the multiplier and basic accelerator process Flashcards
what is AD the determinant of?
Aggregate demand (AD) is a major determinant of overall level of output (GDP) and employment in the economy
Diagram: The Influence of AD on Real GDP
Diagram analysis
When an injection occurs in the economy, such as through increased government spending or investment, the AD curve will shift to the right (AD1 to AD2)
This increases the overall level of real output
When real output increases, firms typically need to hire additional workers to meet the higher demand for goods/services
The increased employment is linked to an increase in economic growth
When a withdrawal occurs in the economy, such as through more taxes or spending on imports, the AD curve will shift to the left (AD1 to AD3)
This decreases the overall level of real output
When real output decreases, firms typically reduce their workforce to align with reduced demand for goods/services
The decreased employment is linked to a decrease in economic growth
what does the multiplier state?
The multiplier states that any injection in the economy leads to a greater impact on the economy than the value of the initial injection
what is the multiplier process based on
The multiplier process is based on the idea that one individual’s spending is another individual’s income
what happens when consumption increases ?
An increase in consumption immediately increases AD
Store owners who have benefited from the extra consumption now have extra income
They spend some of that income on goods and services
Their expenditure on goods and services is now income for the next tier of individuals
Due to the successive rounds of spending, the final increase in national income is much larger than the initial injection
what is the size of the multiplier inlflunced by?
The size of the multiplier is influenced by the size of leakages that occur during the process
The higher the leakages, the smaller the marginal propensity to consume (MPC)
The higher the marginal propensity to consume, the lower the leakages and the greater the multiplier will be
what is the marginal propensity to consume
The marginal propensity to consume (MPC) is the proportion of additional income that is spent on consumption (C)
draw the effect of the multipler diagram
diagram analysis
The initial injection shifts AD to the right, from AD1 to AD3
The result of the multiplier process is that there is then a secondary movement of AD to the right, from AD3 to AD2
If the multiplier were 2, this would double the initial movement
The multiplier can also work in reverse when injections are reduced (downward multiplier effect)
what is the marginal propensity to consume (MPC)
Marginal Propensity to Consume (MPC) is the proportion of additional income that is spent on consumption (C)
It can be viewed as how many pence is spent by households on consumption from every additional £1 of income
how to calculate the MPC
MPC = change in consumption ÷ change in income
how to calculate the multiplier ?
the multiplier = 1 ÷ 1 - MPC
The grater the MPC, the higher the value of the multiplier, and vice versa
what can change the multipler ?
Any change in one of the factors that impacts on disposable income will change the multiplier
If taxes increase, the value of the multiplier reduces
If interest rates increase, savings increase, consumption decreases and the multiplier reduces
If exchange rates appreciate, the level of imports will increase and the multiplier decreases
If confidence in the economy increases consumption increases and the multiplier increases
why is it useful for the government to know the value of the multiplier ?
It is extremely useful for the Government to know the value of the multiplier
They can use it to judge the likely economic growth caused by increased spending
The bigger the MPC, the greater the multiplier effect will be
what does the accelerator process suggest ?
The accelerator process suggests that changes in the level of investment from firms (into capital goods such as machinery, factories, etc) are necessary to meet the changes in the overall level of economic activity
As economy expands, firms invest more into capital goods
As economy contracts, firms invest less into capital goods
how does the accelerator and multiplier work together ?
As the demand for goods and services increase, AD increases
As a result, firms invest more (or make an accelerated investment) into capital goods to meet demand for products in the hope of making a profit
This leads to a further increase in AD
This increase in AD is then multiplied, making growth in national income more rapid
Which leads to an even more accelerated investment into capital goods by firms
