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Question 1

Multiplier Effect

Answer 1

The knock-on effects of an initial change in injections or
withdrawals on national income, which cause national
income to change by more than the initial change;
Multiplier= 1 / (1 - MPC) = 1 / MPW

Additional Information:
A downward (negative) Multiplier effect means an initial
reduction in income will become worse after households
have reduced their spending causing firms to pay out
even less income

Question 2

*Marginal
Propensity to
Consume (MPC)

Answer 2

The proportion of an increase in income which is spent on
domestically produced consumer goods and services

Additional Information:
High MPC increases size of the multiplier; Multiplier= 1 /
(1 - MPC)

Question 3

*Marginal
Propensity to
Withdraw (MPW)

Answer 3

The proportion of an increase in income which is not
spent on domestically produced consumer goods and
services

Additional Information:
High MPW reduces size of the multiplier: Multiplier = 1 /
MPW

Question 4

Investment
(Macro) (I)

Answer 4

Spending by domestic firms on capital goods

Additional Information:
Investment spending yields returns into the future hence
includes new buildings and (in theory) training of staff; is
determined by interest rate, change in income
(accelerator) & business confidence (expected revenues);
also includes house building

Question 5

Accelerator

Answer 5

Principle of investment theory whereby investment
spending by firms responds to change in demand ( or
GDP)

Additional Information:
Hence, a slowing in demand growth produces a fall in I,
but I rises before demand bottoms out; interaction
between accelerator and multiplier can exaggerate the
boom-bust economic cycle

Question 6

Net Trade (X-M)

Answer 6

Net spending on domestic output from foreign trade i.e.
earnings from sale of exported goods and services minus
spending on imported goods and services

Additional Information:
If positive, this will contribute to a rightward shift in AD
and stimulate an upward multiplier effect that should
boost national output and cause inflationary pressure;
positive net trade will boost Balance of Payments on
current account (though latter also includes net
investment income, which does not directly contribute to
AD); UK has had a large negative net trade for many
years which acts as a drag on UK growth

Question 7

Economic
(or Business)
Cycle

Answer 7

The tendency for market economies to grow in a cyclical
pattern typically over a period of 5 to 10 years

Additional Information:
Such cycles have been well documented for over 150
years in the economically advanced economies: there is a
period of ‘boom’ in which real national output grows
relatively fast (say 5% +, for 2-3 years), but which brings
about high inflation and a ‘bust’ in which real growth goes
negative during a recession and unemployment soars;
causal factors: accelerator and multiplier; since 1945 most
governments have tried to dampen down the cycle using
demand management (e.g. reducing tax to stave off
‘bust’)

Question 8

Output Gap

Answer 8

Actual GDP minus sustainable GDP

Additional Information:
Over the course of an economic cycle (boom to boom:
usually 5-10 years) the average annual growth of real
GDP can be estimated (for UK recently this has been 2
3% ): in boom years real GDP will exceed this trend
creating a positive output gap, implying GDP growth
driven by high AD creating inflationary pressure; negative
output gap arises in recession implying AD can rise
without causing inflation