Transcript The Multiplier

THE
MULTIPLIER
AP Macroeconomics
Review

If households have the choice to consume or
save, the marginal propensity to consume
plus the marginal propensity to save must
equal 1.
MPC + MPS = 1
Review
MPC = change in consumption/change in disposable
income
MPS = change in savings/change in disposable
income
…or 1-MPC (because MPC + MPS = 1, then 1-MPC
must equal MPS)
“delta” means
“change in”
And now for…
THE MULTIPLIER…
Investment Demand
This is what
happens if
businesses
decide to spend
more on
investment
goods – output
rises.
The question is: by how
much does output
increase?
This is where the
multiplier comes in!
FOUR ASSUMPTIONS when analyzing
the effects of changes in spending on the
economy
1)
2)
3)
4)
Assume producers are willing to supply
additional output at a fixed price
Take the interest rate as given
Assume there is no government spending
and taxes (no taxes)
Assume exports and imports are zero (no
trade)
Home Improvement…
“The increase in aggregate output
leads to an increase in
disposable income that flows
to households in the form of
profit and wages” (Krugman,
158)
This is why, for example, if home
builders decide to spend an
extra $100 billion on home
construction over the next year
that the increase in housing
investment spending does not
raise the overall income by
$100 billion exactly…
Total isolation…
There’s ripple effect, or a chain reaction…
Multiple Rounds…
“The increase in a household’s
disposable income leads to
a rise in consumer spending
which, in turn, induces firms
to increase output yet
again. This generates
another rise in disposable
income, which leads to
another round of consumer
spending increases, and so
on. So there are multiple
increases in rounds of
aggregate output.”
Technically, to figure this out, we would take the
MPC of round 1 and multiply it by $100
billion. We would then take the MPC of
round 2 and multiply it by $100 billion, and
so on. And then we would add them up:
(1+MPC1+MPC2+MPC3+…) x $100 billion
So what, exactly, is the MULTIPLIER?
1/(1-MPC)
The ratio of the total change in real GDP caused by an
autonomous change in aggregate spending to the
size of that autonomous change.
AUTONOMOUS = “self-governing” (the cause of the
chain reaction)
i.e. the total change in real GDP caused by an
autonomous change in aggregate spending
And now…

Some resources:
http://www.reffonomics.com/textbook2/macroec
onomics2/keynesianthought/keynesiancross.
swf
Works Cited
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Economics of Seinfeld. Saving.
http://yadayadayadaecon.com/concept/saving/
Krugman, Paul, and Robin Wells. Krugman’s
Economics for AP. New York: Worth Publishers.
Morton, John S. and Rae Jean B. Goodman.
Advanced Placement Economics: Teacher
Resource Manual. 3rd ed. New York: National
Council on Economic Education, 2003. Print.
Reffonomics. www.reffonomics.com.