MACRO - LS7 - The Multiplier

Question 1

What’s the multiplier effect

Answer 1

• 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

Question 2

How does the multiplier effect work

Answer 2

• 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

Question 3

What does the size of the multiplier effect depend on

Answer 3

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

Question 4

Multiplier ratio

Answer 4

Injection divided by increase in national income

Question 5

Multiplier formula in a closed economy with no government sector

Answer 5

1/marginal propensity to save

Question 6

Marginal propensity to save

Answer 6

=change in savings/change in income

Question 7

Formula linking MPS & MPC

Answer 7

MPS + MPC = 1

Question 8

Multiplier formula in an open economy with a government sector

Answer 8

there are three withdrawals from the circular flow

Multiplier = 1 / MPS + MPM + MRT

Question 9

What effect does an increase in MPS have on multiplier

Answer 9

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

Question 10

What effect does the multiplier have on AD?

Answer 10

Larger the multiplier, larger increase in national income, larger increase in AD

Question 11

Effects of increase in AD

Answer 11

• 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

Question 12

What’s the value of the multiplier determined by?

Answer 12

Marginal propensities to consume, save, tax and import

Question 13

Increase in interest rate effect

Answer 13

• discourage consumption but encourage saving
• fall in MPC & rise in MPS
• fall in the value of the multiplier

Question 14

Rise in taxes effect

Answer 14

• increases MPT
• multiplier falls

Question 15

How can the multiplier be changed due to imports

Answer 15

• 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

Question 16

Negative multiplier effect

Answer 16

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

Question 17

Factors influencing high multiplier value

Answer 17

• economy having spare capacity
• propensity to import & tax is low
• high propensity to consume any extra income

Question 18

Factors influencing low multiplier value

Answer 18

• economy is close to full capacity
• rising demand causes inflation
• high inflation causing high interest rates

Question 19

Evaluation of multipler

Answer 19

• 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