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Aggregate Expenditures: The multiplier

Learn about how small changes in spending can lead to significant impacts on output and income through the multiplier effect. Discover the relationship between Marginal Propensities and the multiplier, and the significance of this concept in driving economic growth.

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Aggregate Expenditures: The multiplier

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  1. Aggregate Expenditures: The multiplier Chapter 10 Part 2 of Unit 5

  2. Read Page 199 • Squaring the Economic Circle

  3. The Multiplier Effect • Small change in investment leads to a large change in output and income. • The multiplier determines how large the change will be • Multiplier = change in GDPr / initial change in spending • Ex. A $5 billion change in Ig led to a $20 billion change in GDP. • What is the multiplier? • 4

  4. Rationale • The economy has continuous flows of expenditure & income—ripple effect • Income received by person A comes from $ spent from person B. • Change in income will cause both C and S to vary in the same direction as the initial change in income (increase or decease) and by a fraction of that change.

  5. Rationale continued • The fraction of the change in income that is spent is called the MPC • The fraction of the change in income that is saved is called the MPS

  6. Multiplier & Marginal Propensities • The size of the MPC and the multiplier are directly related • The size of the MPS & the multiplier are inversely related • M = 1 / MPS • or • M = 1 / (1-MPC)

  7. Significance of the Multiplier • A small change in investment plans or consumption savings plans can trigger a much larger change in the equilibrium level of GDP

  8. Generalizing the Multiplier • We have seen the simple multiplier • The multiplier can be generalized to include other “leakages” from the spending flow besides savings • Realistic multiplier includes taxes and imports

  9. Magic of the Multiplier Packet Due today

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