The Multiplier-Accelerator Model Flashcards
Multiplier effect
When a change in expenditure causes a greater final change in real GDP
How is the multiplier calculated?
1/MPW = 1/(MPM + MPS + MRT)
Determinants of the size of the multiplier
1. Marginal propensity to save
- If the MPS is high then the multiplier is going to be low as people are saving and not consuming which is a leakage out of the circular flow of income-
- the MPS may be high in a country also during a boom as people want to save more as they have a high income and already able to afford good
- may save during a recession for precautionary reasons as low confidence
- saving depends on age population as younger people tend to save less money
2. Marginal rate of taxation
- taxes are leakages out of the circular flow of income
- marginal rate of taxation is how much tax you pay on the next pound you earn
- income tax has become more progressive over years
- the higher the MRT, the lower the multiplier
3. Marginal propensity to save
- if the MPM is high then the multiplier is low
- MPM is quite high in the UK are more specialized in the financial sector and do not have a lot of natural endowments
- the UK have to import a lot of key commodities from abroad
- due to globalization domestic consumers by from a broad as it is cheaper and of better quality
- the MPM will be high if the imported goods are income inelastic
What are the 2 reasons why investment is needed?
1. Firms animal spirits are aroused
- firms expect an increase in demand
2. Machinery that is used continuously becomes depreciated
- firms would need to invest into new machinery to continue to producing
What happens to investment when an economy is growing?
When the economy is increasing, investment is also increasing
The accelerator effect
When an increase in national income results in a proportionally larger increase in capital investment
Why does this explain the boom phase of the economic cycle?
In the boom phase, output is increasing so Investments increase
- this causes a multiplier effect and then accelerator effect
What does the accelerator model explain what happens once the peak in the economic cycle is reached?
There is no more labor available to sustain the boom as resources become scarce and economy is operating at full capacity
- this puts a break in the economy and slows down the rate of economic growth
- this means that firms have a pessimistic outlook and so confidence decreases
- this leads to a slow down in the economy which leads to a negative multiplier effect
- in a recession they may be high levels of spare capacity so may not need to invest in new capital
- due to low confidence consumers may not spend so consumption is low and so firms do not expect a return so may not invest
Why does the economy eventually reach a point where it begins to recover again?
There will be a time to invest when machinery and capital becomes worn out and depreciates
- in a recession, consumption will still continue to increase eventually as people need to maintain their standards of living
The interaction of the multiplier and accelerator effect gives rise to the cyclical response to initial shocks
- an increase in investment could increase the quality and quantity of fop
- increases the productive capacity of the economy
- LRAS shifts to the right due to capital investments
- AD also shifts as investments is a compornent of AD
- non-inflationary growth
What does the accelerator effect depend upon?
1. Depends upon the level of spare capacity
- if there is lots of spare capacity, firms wont need to invest into a lot of capital as they are operating on the ppf curve
- if there is a negative output gap or in a recession there is a lot of spare capacity
- if approaching recovery the factors of production become more scarce as you come closer to the PPF
2. Flexibility of investment decisions
- firms will have to invest irrespective of the accelerator effect because they have committed to decisions
- cannot stop a contract randomly so difficult to halt these advanced investments
3. Depends upon the availability of financial capital
- depends on the economic cycle
- during a recession firms may not be trusted by banks and may not have a history of making enough profits or banks are reluctant to give money to firms
- small firms do not have enough collateral to secure loans and so less likely to invest
4. Depends on the degree of consumer confidence
- the higher the level of confidence, the higher the level of investments within an economy
- the extent to which firms respond to increase demand is not inevitable
- accelerator effect is not always inevitable even when demand is rising
