Transcript The Multiplier Long Run Economic Growth

Multiplier Effect
A2 Economics
Lesson Objectives
Understand the multiplier concept
Utilise the multiplier formula
Explain the multiplier determinants
Analyse the interaction of the multiplier,
accelerator and economic cycle
Evaluate the significance of marginal
propensity to save, tax and import
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The Multiplier effect
Process by which any change in a
component of AD results in greater final
change in real GDP
The size of the multiplier is determined by
the size of the leakages from the circular
flow of income
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The circular flow of income
Firms
Factor
payments
Consumption of
domestically
produced goods
and services (Cd)
Households
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The circular flow of income
INJECTIONS
Export
expenditure (X)
Investment (I)
Factor
payments
Consumption of
domestically
produced goods
and services (Cd)
Government
expenditure (G)
BANKS, etc
Net
saving (S)
GOV.
ABROAD
Import
Net
expenditure (M)
taxes (T)
WITHDRAWALS
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The Multiplier Effect
 Government increases spending on education,
raising wages of teachers by £5 billion.
(Injection)
 Teachers spend this money, which in turn
becomes income for other people.
 The proportion of income that goes towards
leakages is the Marginal Propensity to
Withdraw. Let’s assume half the injection goes
towards savings, tax or imports. That means the
MPW is 0.5. What happens real GDP?
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This square represents the initial increase
in income (£5bn)
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If marginal propensity to withdraw is 0.5;
half is spent (MPC 0.5)
spent
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The amount spent is income for other
people
Income
for others
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Total income so far
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Half the new income is spent
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Total income so far
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Half the new income is spent and
becomes income for other people
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Total income so far
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Eventually…
 The initial £5bn eventually becomes £10bn
through the multiplier effect. National income
has been multiplied by factor of 2.
 Formula
K (multiplier) =
1/MPW
(1/0.5 = 2)
MPW = MPS + MPT + MPM
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MPW
 MPC +MPS + MPT + MPM = 1
 The smaller the value of the withdrawals (and the larger the value of
 theMPC) the larger the value of the multiplier.
 MPS
 Change in S / Change in Y
 MPT
 MPM
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 £6bn is due to be spent by the UK government
in order to prepare London for
 the 2012 Olympics. This will bring a significant
multiplier effect upon the UK
 Economy. MPW is 0.3, Calculate multiplier?
 Therefore change to national income following
£6bn injection £6bn * 1/(0.3) = £19.9bn
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Activities
 If the multiplier is 2.5 and government wants to
raise real GDP by £150bn. How much would it
raise spending by.
 If exports revenue fell by £8bn and as a result
real GDP declines by £12bn, what is the size of
the multiplier?
 New Zealand’s trade balance deteriorated
between ’03-’06. However, real GDP increased.
Explain.
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Accelerator
 The theory of investment that states the level of
investment depends on the rate of change of
national income
 Recession
Firms decrease invest
 Boom
Firms increase invest
Investment depends on RATE OF CHANGE OF
Y, not on its actual level.
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Interaction of Multiplier & Accelerator
This is a theoretical explanation of the
Economic Cycle.
Economy growing leads to investment
which leads to a multiplier effect which
leads to further economic growth
However, if economy in recession the
effect works in the opposite direction.
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Evaluating the Interaction of Multiplier &
Accelerator Model
 Ignores the role of CONFIDENCE. Economy might be
growing, but do businesses think it will be sustained?
 Investment decisions are large and complex, made well
before changes in the economic conditions
 Exogenous factors just as influential
 ‘No more boom and bust’ – Governments can smooth out
the economic cycle through fiscal and monetary policies
 However, investment is an important component of AD
and firms do respond to consumer demands. The
multiplier model is not the only force behind the economic
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cycle.
Plenary
 International comparisons of multiplier values
reveal significant variations between countries.
One estimate suggested that the multiplier
values were 1.42 for the UK, 1.13 for Germany
and 1.76 for Japan.
Explain why the multiplier may vary between
countries
 Explain how a change in the rate of income tax
is likely to affect the size of the national income
multiplier
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