MACRO - LS7 - The Multiplier Flashcards
What’s the multiplier effect
- final change in equilibrium national output resulting from an initial change in aggregate demand
- An initial change in an injection or leakage can have a greater final impact on equilibrium national income
How does the multiplier effect work
- The multiplier effect comes about because iniections of demand into the circular flow of income stimulate further rounds of spending - because one person’s spending is another’s income.
- This leads to a bigger final effect on the level of national output and total employment in the labour market.
CGP example
What does the size of the multiplier effect depend on
The rate at which money leaks out of the circular flow
- the bigger the leakages, the quicker the money will leave the circular flow and the smaller the effect will be
Multiplier ratio
Injection divided by increase in national income
Multiplier formula in a closed economy with no government sector
1/marginal propensity to save
Marginal propensity to save
=change in savings/change in income
Formula linking MPS & MPC
MPS + MPC = 1
Multiplier formula in an open economy with a government sector
there are three withdrawals from the circular flow
Multiplier = 1 / MPS + MPM + MRT
What effect does an increase in MPS have on multiplier
As it increases, multiplier decreases as MPS is saving so there is less spending on the economy therefore there is less change in national output
What effect does the multiplier have on AD?
Larger the multiplier, larger increase in national income, larger increase in AD
Effects of increase in AD
- higher output (higher economic growth)
- higher employment due to an increase in firm’s need for labour (to produce additional goods/services demanded)
- higher inflation if economy isn’t in recession
What’s the value of the multiplier determined by?
Marginal propensities to consume, save, tax and import
Increase in interest rate effect
- discourage consumption but encourage saving
- fall in MPC & rise in MPS
- fall in the value of the multiplier
Rise in taxes effect
- increases MPT
- multiplier falls
How can the multiplier be changed due to imports
- any factor other than income that changes imports will change multiplier
- one way is that there is an increase in the quality of imported goods
- increases imports and MPM
- reducers multiplier value
Negative multiplier effect
Occurs when an initial withdrawal or leakage of spending from the circular flow leads to knock-on effects and a bigger final drop in real GDP
Factors influencing high multiplier value
- economy having spare capacity
- propensity to import & tax is low
- high propensity to consume any extra income
Factors influencing low multiplier value
- economy is close to full capacity
- rising demand causes inflation
- high inflation causing high interest rates
Evaluation of multipler
- difficult to measure exact size of multiplier - hard to measure
- takes time for multiplier process to feed through to GDP - time lag
- economists disagree over size
- long run multiplier effect is likely higher developing economies than for developed ones; infrastructure projects often have higher multiplier effects
