Transcript Chapter 10 - Humble ISD

Chapter 10
The Multiplier, Net Exports, &
Government
Introduction
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We will examine why is GDP unstable and
subject to cyclical fluctuations.
We will also introduce the Government & the
foreign sector into the aggregate spending
model.
We will then apply the model into both the
Vietnam War & the Great Depression
Changes in Equilibrium & the
Multiplier
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GDP responds to changes in both consumption
& investment. The primary focus for this
chapter will be investment
Increase in investment spending leads to an
exponential increase in equilibrium GDP.
This is known as the Multiplier Effect
Continuing the Multiplier
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Initial change in spending is usually associated
w/ investment due to volatility
The “initial change” is represented by upward or
downward movement on the graph (Aggregate
Expenditure Schedule)
Multiplier works in both directions (up or down)
Basic Facts of the Multiplier
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The Economy has continuous flows of
expenditures and income – a ripple effect
Change in income will cause consumption and
savings to change in the same direction
The size of the MPC and the Multiplier are
directly related, the MPS is inversely related to
the multiplier
Significance
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Small changes in investment plans or
consumption can trigger large changes in
equilibrium GDP.
Simple Multiplier vs. Complex
Simple does not include the effect of savings,
taxes, & imports
Net Exports
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Positive Net Exports increase aggregate
spending and then GDP as well
Negative Net Exports decrease both
What relationship would tariffs have on GDP?
What about depreciation of the dollar?
Prosperity abroad typically indicates prosperity
at home.
Questions
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What is the multiplier effect?
What relationship does the MPC bear to the size of the
multiplier? The MPS?
Calculate the multiplier if the MPS is 0, .4, .6, and 1
Calculate the multiplier if MPC is 1, .9, .67, .50, and 0
How much will GDP increase if investment increases 8
billion and the MPC is .8?
What is the difference between the complex & simple
multiplier?
The Public Sector
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Government spending boosts aggregate
expenditures yet reduce disposable income
Government purchases also subject to the
multiplier
Taxes will cause disposable income to fall short
How short is determined by multiplying the
MPC and MPS by the total tax revenue
Injections, Leakage, & Unplanned
Inventory
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Savings, Imports, Taxes are all considered
leakages to the stream of spending
Investments, Exports, & Government Purchases
are all considered injections
At equilibrium GDP, these two will equal each
other (Injections = Leakages @ =GDP)
Balanced Budget Multiplier
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Equal increases in Government spending and
taxation increase the equilibrium GDP.
Changes in government spending affects
aggregate spending more powerfully than a tax
change of the same size.
Balanced Budget Multiplier is always one
Equilibrium & Full GDP
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Recessionary gaps exists when equilibrium GDP
is below full employment GDP. In other words,
we are capable of making more
Inflationary Gaps exist when aggregate
expenditures cannot achieve equilibrium at full
employment.
Limitations of the Model
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The Aggregate Spending model does not
measure inflation – It will show an inflationary
gap, it will not however show the exact price
level increase
Does not allow for GDP to increase once full
employment is reached
Does not allow for cost push inflation