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Aggregate Expenditures: The multiplier

Aggregate Expenditures: The multiplier. Chapter 10 Part 2 of Unit 5. Read Page 199. Squaring the Economic Circle. 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

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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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