Multiplier Effect Flashcards
Describe how an increase in income leads to an even further increase in government spending investment and AD
Increase in incomes (increase in consumption)-higher sales and profits for firms (increasing investment)-Government collects more revenue through income tax,corporate tax and VAT (increasing government spending)-Increasing AD
Describe how an increase in government spending leads to a further increase in investment,consumption and AD
Increase in the building of schools and hospitals (increase in G)-higher employment and increase in incomes-workers spend more (increase in C)-firms make more sales and profits allowing them to expand (increase in I)-Government collects even more revenue (further increase in G)
This will all lead to an increase in AD
Define the term Multiplier effect
When an initial increase in injections (C,I or G) leads to further increase in aggregate demand
How do we calculate the multiplier ratio involving real GDP and initial injection
Total change in real GDP/initial injection
What does the multiplier ratio tell us
How much real GDP will increase following an initial injection into the economy
What is the formula involving Multiplier and MPC
Multiplier ratio=1/(1-MPC)
What is MPC and define it
MPC-Marginal propensity to consume tells us how likely consumers are to spend given an increase in income
What is the formula the multiplier ratio involving MPW
Multiplier=1/MPW
NOTE:MPW=MPS
What is the equation involving MPW and MPC
MPC+MPW=1
What is the formula for MPW when you are not given MPC
MPW= MPS+MPT+MPM
MPS= Marginal Propensity to save
MPM=Marginal propensity to imports
MPT=Marginal propensity to tax
What is the formula for Multiplier involving MPS,MPT and MPM
Multiplier=1/(MPS+MPM+MPT)
Explain the downward multiplier effect starting off with an incerease in income tax
increase in income tax-decrease in disposable income-households will spend less-decrease in consumption-firms make less sales and profits-firms have less money to invest-investment decreases-firms lay off more workers-decrease in income and consumption-government receives less income tax and corporation tax revenue-government spending decreases-AD decreases
What effect does the downward multiplier effect have on the AD curve
It will shift the AD curve inwards
Define the downward multiplier effect
When an initial increase in withdrawals leads to an even larger decrease in Aggregate Demand
