the multiplier and accelerator Flashcards
multiplier definition
the process by which a change in a component of aggregate demand results in a greater final increase in real GDP
how does the multiplier work
a component of aggregate demand increases, for example government expenditure on a new motorway. this directly increases AD and GDP, but then the builders hired to make the motorway spend their increased wages when the money flows around again, this time increasing AD via consumer spending, less of an increase than last time though. then the money flows around again as the cafes they spend their money in hire more staff who in turn spend more, shifting AD out again. Lots of economic growth from one initial boost
multiplier equation
1/marginal propensity to withdraw
OR 1/1-marginal propensity to consume
MPW
marginal propensity to withdraw
what is MPW made up of
marginal propensity to save, import and tax
marginal propensity meaning
what proportion of any additional unit injected into the economy is….
MPC
marginal propensity to consume
determinants of the size of the multiplier
the size of the withdrawals from the economy, which depends on confidence in the economy, budget deficit etc.
what is the multipliers relationship to MPW
inversely proportional. as the MPW increases, the multiplier decreases.
APS
average propensity to save, ratio of total saving to total income. Total saving/total income.
APC
average propensity to consume. ratio of total consumption to total income. total consumption divided by total income.
APW
Average propensity to withdraw. the proportion of total income that leaks from the economy (savings taxes and imports)
what is the accelerator
the process by which an initial increase in national income (GDP) results in a proportionately larger increase in capital investment spending.
how does the accelerator work
as real GDP rises, as does demand meaning firms need to make fuller use of their existing capacity and FOPs. they may choose to invest in new machinery to meet more demand which they expect in the future, so invest MORE than they need to meet the demand at the time.
what principle does the accelerator effect state
a given change in the demand for consumer goods will cause a greater percentage change in demand for capital goods
who developed the multiplier effect theory
keynes
how do the multiplier and accelerator link after an initial increase in GDP
the increase in GDP activated the accelerator effect, meaning firms invest more to meet higher demand. this investment boosts AD, meaning GDP rises again. Then the boost in AD activates the multiplier, meaning people who now have jobs spend more money, boosting AD again increasing GDP. this activated the accelerator and the process repeats
what does investment depend on
how fast GDP is growing because this will impact the accelerator effect
