AD and Supply

Question 1

define multiplier effect

Answer 1

• occurs when an initial injection into the circular flow causes a bigger final increase in real national income
  = injection of demand might come from an increase in any AD components such as C+I+G+X-M
• arises because one agent’s spending is another agent’s income so that when a spending project creates new jobs, this creates extra injections of income and demand into a country’s circular flow

Question 2

multiplier equation

Answer 2

1/ 1-MPC
- MPC is marginal propensity to consume
= after each extra amount of money is generated in terms of income, how much will be spent

Question 3

chain of analysis of example of multiplier effect

Answer 3

• new housing project injects £200 mil of excess demand and output into economy
  = many firms benefit directly e.g. architects or building supply companies
  = constructing new houses generates new flow of factor incomes including wages and profits
  = if this extra money stays inside circular flow of income it will create multiplier effect to increase GDP and growth

Question 4

describe negative multiplier effect

Answer 4

occurs when an initial withdrawal or leakage of spending from circular flow leads to knock-off effects and a bigger drop in real GDP
- e.g. 2021, Swindon Honda factory closed down which caused a loss of 3,000 jobs

Question 5

determinants of MPC

Answer 5

• if marginal propensity to import is low, there’s lower value of MPC= lower AD change= smaller multiplier
• if there’s high tax levels, there’s less spending= lower multiplier value
• if there’s high incentive or culture to save e.g. due to high IRs= less spending= less AD= lower multiplier

Question 6

define accelerator effect

Answer 6

change in investment can be directly linked to a change in the rate of GDP growth
= if there’s rapid economic growth, firms are more willing to invest
= firms will expect higher AD in future due to expectations of high growth
= best time for firms to invest in new capital etc

Question 7

chain of reasoning for accelerator effect

Answer 7

• positive accelerator effect occurs when increase in rate of growth of consumer demand leads to increase in planned capital investment by firms
• e.g. if there’s high demand for streaming services, may lead firms like Netflix to increase investment in server hardware
• firms will increase capital spending as they need extra supply capacity and want to max profits in LR
  = lead to higher net investment
  = increase size of economy’s capital stock
  = increase productive capacity and potential due to more output and efficiency per worker
  = create outward shift of LRAS or outward shift of PPF