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1. The Multiplier Model Chapter 10
2. LAUGHER CURVE “If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.”
Winston Churchill
3. The Multiplier Model The multiplier model explains how an initial shift in expenditures changes equilibrium output when the price level is fixed.
An initial expenditure shift causes additional induced (multiplier) effects.
4. The Multiplier Model The multiplier model quantifies the effect of changes in aggregate expenditures on aggregate output.
5. The AS/AD Model When Prices Are Fixed
6. Aggregate Production Aggregate production –the total amount of goods and services produced in every industry in an economy.
Production creates an equal amount of income.
7. Aggregate Production Graphically, aggregate production in the multiplier model is represented by a 45° line through the origin
8. Aggregate Production Real production (in dollars) is on the vertical axis, and real income (in dollars) is on the horizontal axis.
9. The Aggregate Production Curve
10. Aggregate Expenditures Aggregate expenditures – the total amount of spending on final goods and services in the economy:
Consumption – spending by consumers.
Investment – spending by business.
Spending by government.
Net foreign spending on U.S. goods – the difference between U.S. exports and imports.
11. Autonomous and Induced Expenditures Autonomous expenditures – expenditures that do not systematically vary with income.
Induced expenditures – expenditures that change as income changes.
12. Autonomous and Induced Expenditures Autonomous expenditures is the level of expenditures at zero income.
13. Autonomous and Induced Expenditures Induced expenditures are those that change as income changes.
14. The Marginal Propensity to Expend Marginal propensity to expend (mpe) – the ratio of the change in aggregate expenditures to a change in income.
It is composed of the various relationships between the component of aggregate expenditures.
Its value is greater than 0 and less than 1.
15. Components of the Marginal Propensity to Expend Marginal propensity to consume (mpc) – the change in consumption that occurs with a change in income.
The mpc is less than 1 because individuals tend to save a portion of an increase in income.
16. Components of the Marginal Propensity to Expend Income taxes reduce people’s incomes which lowers their expenditures.
17. The Aggregate Expenditures Function The relationship between aggregate expenditures and income can be expressed mathematically.
18. Expenditures Function Autonomous expenditures is the sum of the autonomous components of expenditures:
19. Graphing the Aggregate Expenditures Function Situation 1:
Autonomous consumption = 100
Autonomous investment = 40
Autonomous net exports = 30
Autonomous government spending = 20
The marginal propensity to expend = 0.6
20. Graphing the Aggregate Expenditures Function Situation 2:
21. Graphing the Aggregate Expenditures Function Situation 3:
22. Graphing the Expenditures Function
23. Shifts in the Expenditures Function The aggregate expenditure curve shifts when autonomous C, I, G, or (X – M) change.
24. Shifts in the Expenditures Function Shifts in aggregate expenditures lead to a change in income from its existing level.
25. Determining the Equilibrium Level of Aggregate Income In bringing AP and AE together in one framework, the following is assumed:
The AP curve is a 45ş line until the economy reaches its potential income.
Aggregate expenditures equal aggregate income at all points on the AP curve.
Planned expenditures on the AE line do not necessarily equal production or income.
26. Determining the Equilibrium Level of Aggregate Income At equilibrium, planned expenditures must equal production.
27. Solving for Equilibrium Graphically
28. The Multiplier Equation The multiplier equation tells us that income equals the multiplier times autonomous expenditures.
Y = Multiplier X Autonomous expenditures
29. The Multiplier Equation Expenditures multiplier – a number that reveals how much income will change in response to a change in autonomous expenditures.
30. The Multiplier Equation As the mpe increases, the multiplier increases:
31. The Multiplier Process When aggregate production do not equal aggregate expenditures:
Businesses change production levels,
Which changes income, which changes expenditures,
Which changes production, which changes income,
Which changes . . . etc.
32. The Multiplier Process The process ends when aggregate production equals aggregate expenditures.
33. The Multiplier Process
34. The Circular Flow Model and the Multiplier Process The circular flow model provides the intuition behind the multiplier process.
The flow of expenditures equals the flow of income.
35. The Circular Flow Model and the Multiplier Process
36. The Circular Flow Model and the Multiplier Process Not all of the flow of income is spent on domestic goods (the mpe < 1).
37. The Circular Flow Model and the Multiplier Process The multiplier process is much like a leaking bathtub.
38. The Multiplier Model in Action The multiplier model illustrates how a change in autonomous expenditures changes the equilibrium level of income.
39. The Multiplier Model in Action Autonomous expenditures are determined outside the model and are not affected by changes in income.
40. The Steps of the Multiplier Process The income adjustment process is directly related to the multiplier.
Any initial shock (a change in autonomous AE) is multiplied in the adjustment process.
41. The Steps of the Multiplier Process The multiplier process repeats and repeats until a new equilibrium level is finally reached.
42. Shifts in the Aggregate Expenditure Curve
43. The First Five Steps of Four Multipliers
44. The First Five Steps of Four Multipliers
45. Examples of the Effect of Shifts in Aggregate Expenditures There are many reasons for shifts in autonomous expenditures:
Natural disasters.
Changes in investment causes by technological developments.
Shifts in government expenditures.
Large changes in the exchange rate.
46. An Upward Shift of AE
47. An Downward Shift of AE
48. The United States at the Turn of the Millennium The economy boomed from 1998-2001 and fell into a recession after September 2001.
Substantial increases in consumer confidence increased autonomous consumption through mid-2001.
Consumer spending and investment fell after the terrorist attacks in September 2001.
49. Japan in the 1990s Aggregate income and production fell during the 1990s.
A dramatic rise in the yen cut Japanese exports.
Autonomous consumption decreased as consumers confidence fell
Suppliers responded by laying off workers and cutting production.
50. Fiscal Policy in the Multiplier Model Policymakers believe they can use government policies to shift the AE curve in an attempt to achieve the desired level of output.
51. Fighting Recession: Expansionary Fiscal Policy Expansionary fiscal policy is appropriate when the economy is in a recessionary gap.
The increased spending leads to a multiple increase in aggregate expenditures, thereby closing the gap.
52. Fighting Recession: Expansionary Fiscal Policy
53. Fighting Inflation: Contractionary Fiscal Policy Contractionary fiscal policy is appropriate when the economy is in an inflationary gap.
The decreased spending leads to a multiple decrease in aggregate expenditures, thereby closing the gap.
54. Fighting Inflation: Contractionary Fiscal Policy
55. Limitations of the Multiplier Model On the surface, the multiplier model makes a lot of intuitive sense.
Surface sense can often be misleading.
56. The Multiplier Model Is Not a Complete Model The multiplier model does not determine income from scratch.
At best, it can estimate the directions and rough sizes of autonomous demand or supply shifts.
57. Shifts Are Not as Great as Intuition Suggests The aggregate expenditure shifts that occur in response to a shift in autonomous expenditures may be overemphasized.
58. The Price Level Will Often Change in Response to Shifts in Demand The multiplier model assumes that the price level is fixed.
The price level can change in response to changes in aggregate demand.
59. Forward-Looking Expectations Complicate the Adjustment Process People's forward-looking expectations make the adjustment process much more complicated.
Most people, however, act upon their expectations of the future.
60. Forward-Looking Expectations Complicate the Adjustment Process Business people may not automatically cut back production and lay-off workers if they think a fall in sales is temporary.
61. Forward-Looking Expectations Complicate the Adjustment Process Rational expectations model – all decisions are based upon the expected equilibrium in the economy.
62. Shifts in Expenditures Might Reflect Desired Shifts in Supply and Demand Shifts in demand can occur for many reasons.
Many shifts can reflect desired shifts in aggregate production which are accompanied by shifts in aggregate demand.
63. Shifts in Expenditures Might Reflect Desired Shifts in Supply and Demand Shifts may be simultaneous shifts in supply and demand that do not necessarily reflect suppliers' responding to changes in demand.
64. Shifts in Expenditures Might Reflect Desired Shifts in Supply and Demand Expansion of this line of thought has led to the real business cycle theory of the economy.
65. Shifts in Expenditures Might Reflect Desired Shifts in Supply and Demand Real business cycle theory of the economy – fluctuations in the economy reflect real phenomena such as simultaneous shifts in supply and demand, not simply supply responses to demand shifts.
66. Expenditures Depend on Much More Than Current Income People may base their spending on lifetime income, not yearly income.
The marginal propensity to consume out of changes in current income could be very low, even approaching zero.
67. Expenditures Depend on Much More Than Current Income The expenditures function would essentially be a flat line.
68. Expenditures Depend on Much More Than Current Income This set of arguments is called the permanent income hypothesis.
69. The Multiplier Model End of Chapter 10
