the multiplier Flashcards
definition of the multiplier
the ratio of the change in income caused by a change in spending
what is the value of the multiplier determined by?
MPC
effect of a change in investment component of AE?
does not have a once off impact on the economy. any addiction or reduction in the level of AE will have far reaching effects on the aggregate level of output and income
therefore, any change in I results in a multiplied change in Y and O
multiplier coefficient formula
K = 1/MPS
change in income formula
K x change in I
change in output formula
K x change in I
what determines the size of the multiplier?
MPC and MPC
when will the multiplied effect by greater?
when MPC rises or MPS falls
what will cause a multiplied decrease in income?
a fall in investment, government spending or exports
formula for complex multiplier
K = 1/(MPS+MPT+MPM)
what are the macroeconomic policy objectives?
- sustainable econ growth
- price stability
- full employment
- productivity and efficient allocation
- equitable redistribution of income
what is the definition of sustainable economic growth?
the increasing capacity of an economy to satisfy the material needs and wants of the population
what is the target for growth?
3-4%
what occurs with growth of less than 2%?
- difficult to achieve full employment
- represents an economy operating below full capacity
- cyclical unemployment, incomes, living standard and production levels decrease
what occurs with growth above 5%?
- leads to inflation due to higher demand for goods, services and resources
- not sustainable due to resource depletion, production bottlenecks, inflationary pressure and supply side constraints
economic growth equation
(GDP 2 - GDP 1) / GDP 1 X 100
why is growth seen as the most important objective?
helps the economy to achieve other macroeconomic goals and improve living standards
what are the effects of high inflation?
places pressure on interest rates, reduces demand for goods and services as it reduces purchasing power if incomes do not rise in line with price rises, increase in production costs, decreases consumer and business confidence and discourages productive investment from firms
what are the effects of low inflation?
maintains the value of money, protects savings, helps keep interest rates low, promotes international competitiveness and reduces uncertainty for decision makers facing an uncertain future
inflation equation
(CPI 2 - CPI 1) / CPI 1 X 100
what is headline inflation?
- the main measure of inflation as reported in the media
- can be a distorted measure of inflation due to the inclusion of items with high price fluctuations as well as one off events
what is underlying inflation?
provides a more genuine and accurate representation of inflation by excluding once off and volatile items
what are the positives of price stability?
- value of money being maintained
- savings not being eroded
- lower interest rates
- investment in productive assets
- international competitiveness
- reduction in uncertainty leading to increased job creation and investment
- income distribution not being distorted
what are the costs of price stability?
- inflation redistributes income unexpectedly.
- lenders are worse off
- those with market power and asset owners may be able to ‘hedge against’ the price increases and maintain real incomes
- inflation reduces international competitiveness
- imports will increase
- currency depreciation which may cause imports to increase leading to even more inflation
what is the definition of full employment?
full employment occurs when every member of the economy who is both willing and able to work can find a job
what is the target rate for employment?
4-5%
definition of unemployed
those who are willing and able to work, but are unable to find job. they are actively seeking work
at full employment is their cyclical unemployment?
no
how does frictional unemployment increase in a boom?
increased confidence and labour shortages cause more householders to voluntarily leave a job in search for a better one
how does structural unemployment increase in a boom?
investment changes the structure of the economy
formula for unemployment
unemployed / labour force X 100
why is the unemployment rate understated?
hidden unemployment and underemployment
why does unemployment represent a GDP gap?
inside the PPF so resources aren’t being used efficiently which can cause inflation to rise and growth to slow
how does unemployment effect the government?
lose revenue and must increase G1. they may have to shoulder responsibility for increasing growth through discretionary G2
how does unemployment represent opportunity cost?
loss of potential investment projects, which are spent on welfare
