9) The Muliplier Flashcards
Give an example of the multiplier effect when the government builds a school
➡️government spends money on building schools
➡️builders get paid and take money home
➡️spends money on consumption e.g pub
➡️this money contributes to the bar staff income
➡️they spend money on shopping
What is the multiplier
✅positive multiplier effect
➡️ injection into the circular flow leads to a proportionately greater increase in AD
❎negative multiplier effect
➡️leakages from the circular flow leads to a proportionately greater decrease in AD
In the multiplier diagram why is the second shift of AD smaller than the initial injection
➡️Some of the money will be spent on withdrawals
➡️therefore it leaks out of the circular flow
➡️income tax
➡️buy more imported goods and services
➡️save money
What is the multiplier formula
1 / 1-MPC
What does MPC mean
Proportion of extra income that is spent
For example:
If people spend 80% of their extra income
What would be the multiplier
1 / 1-0.8
= 1 / 0.2
= 5
If the multiplier equals to 5 and government spending increases by £30bn, then what is the final change in GDP
5x£30bn=£150bn
What is the 3 evaluation of the multiplier
❎ difficult to measure
❎time lags
❎the multiplier effect depends on the size of withdrawals or leakages
Why is the multiplier difficult to measure
➡️economy is very complex
➡️when using complex mathematical calculation
➡️difficult to get accurate calculation of the multiplier
Why does the multiplier have time lags
➡️full effect on GDP of an increase in government spending, will not be immediate
➡️takes time fir money to move around the circular flow
Why does the multiplier effect depends on the size of withdrawals or leakages
➡️an economy that imports or spends a lot
➡️has a small multiplier effect
