CH30 The multiplier Flashcards
What is the multiplier effect or process?
an increase in investment or other injection will lead to an even greater increase in income (assuming the injection is not determined by income)
What did Keynes argue that the multiplier effect would increase?
he argued that this multiplier effect would increase jobs in the economy.
-every job directly created by firms through extra spending would indirectly create other jobs in the economy.
-this process can be shown using the circular flow of income model (pg147, figure 1)
What does the multiplier model state about leakages from the circular flow?
-the multiplier model states that the higher the leakages from the circular flow, the smaller will be the increase in income which continues to flow round the economy at each stage following an initial increase in spending.
-hence, the higher the leakages, the smaller the value of the multiplier.
-leakages are what is not spend. So another way of saying this is that the multiplier is smaller when the ratio of consumption to income is lower
what is the formula for the marginal propensity to consume?
increase in consumption / increase in income
what is the formula for the marginal propensity to save?
the increase in saving / increase in income
what is the formula for the marginal propensity to tax?
the increase in tax revenues / increase in income
what is the formula for the marginal propensity to import?
the increase in imports / increase in income
what is the formula for the marginal propensity to withdraw?
the increase in withdrawals from the circular flow (S + T + M) divided by the increase in income that caused them
-this is the same as the sum of the marginal propensity to save, tax and import.
what is the formula used to calculate the multiplier?
it can be calculated from the marginal propensities to consume, withdraw, save, tax and import
-so the formula is: 1 / (1 - MPC)
-which is equal to: 1 / (MPS + MPT + MPM)
changes in the marginal propensities to consume, save, tax and import will change the value of what?
will change the value of the multiplier
-an increase in the marginal propensity to consume, which must come about because one or more of the marginal propensities to save, tax, or import have fallen, will lead to a rise in the value of the multiplier.
-this is because a rise in the MPC, which means a fall in the MPW, reduces the number on the bottom of the fraction (of the formula to calculate the multiplier)
what affect will a fall in the MPC have on the multiplier?
a fall in the MPC, which must be associated with a rise in the MPW, will lead to a fall in the value of the multiplier
what affect will a large rise in interest rates have on the multiplier?
it will likely lead to a fall in the value of the multiplier
what affect is a rise in household wealth likely to have on the multiplier?
it is likely to raise the marginal propensity to consume and so lead to a rise in the value of the multiplier
what affect will an increase in gov taxes have on the multiplier?
a rise in taxes will increase the MPT. Hence the value of the multiplier will fall
what are the 3 issues with the multiplier?
-it is difficult to measure the exact size of the multiplier. Sophisticated econometric models have to be used which describe the workings of the economy. They are not completely accurate. Equally, changes can happen in an economy which can alter the size of the multiplier from one period to the next
-the multiplier is not instantaneous. A £100 increase in gov spending today does not increase national income by £200 today. It takes time for the money to flow round the circular flow. So there are time lags between the increase in the gov spending and the final increase in national income.
-economists disagree about the exact size of the multiplier. However, in general it is considered to be relatively low in high income countries such as the UK and the USA at around 0.5. This means an increase in gov spending of £100, or an increase in exports of £100, only generates an extra £50 in GDP (Y)
