Aggregate Aggregate Expenditures: The Expenditures: The multipliermultiplier

Chapter 10Chapter 10

Part 2 of Unit 5Part 2 of Unit 5

Read Page 199Read Page 199

Squaring the Economic CircleSquaring the Economic Circle

The Multiplier EffectThe Multiplier Effect Small change in investment leads to a Small change in investment leads to a

large change in output and income.large change in output and income. The multiplier determines how large the The multiplier determines how large the

change will bechange will be Multiplier = change in GDPr / initial change Multiplier = change in GDPr / initial change

in spendingin spending Ex. A $5 billion change in Ig led to a $20 Ex. A $5 billion change in Ig led to a $20

billion change in GDP.billion change in GDP. What is the multiplier?What is the multiplier?

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RationaleRationale

The economy has continuous flows of The economy has continuous flows of expenditure & income—ripple effectexpenditure & income—ripple effect Income received by person A comes from $ Income received by person A comes from $

spent from person B.spent from person B. Change in income will cause both C and Change in income will cause both C and

S to vary in the same direction as the S to vary in the same direction as the initial change in income (increase or initial change in income (increase or decease) and by a fraction of that decease) and by a fraction of that change.change.

Rationale continuedRationale continued

The fraction of the change in income that The fraction of the change in income that is spent is called the MPCis spent is called the MPC

The fraction of the change in income that The fraction of the change in income that is saved is called the MPSis saved is called the MPS

Multiplier & Marginal Multiplier & Marginal PropensitiesPropensities

The size of the MPC and the multiplier The size of the MPC and the multiplier are directly relatedare directly related

The size of the MPS & the multiplier are The size of the MPS & the multiplier are inversely relatedinversely related

M = 1 / MPS M = 1 / MPS oror

M = 1 / (1-MPC)M = 1 / (1-MPC)

Significance of the Significance of the MultiplierMultiplier

A small change in investment plans or A small change in investment plans or consumption savings plans can trigger a consumption savings plans can trigger a much larger change in the equilibrium much larger change in the equilibrium level of GDPlevel of GDP

Generalizing the Generalizing the MultiplierMultiplier

We have seen the simple multiplierWe have seen the simple multiplier The multiplier can be generalized to The multiplier can be generalized to

include other “leakages” from the include other “leakages” from the spending flow besides savingsspending flow besides savings Realistic multiplier includes taxes and Realistic multiplier includes taxes and

importsimports