Transcript Multiplier

Changes in Macroeconomic
Activity
The Business Cycle
• The phases of the business cycle are:
•
•
•
•
Recovery or Expansion,
Peak or Boom (shaded green)
Recession or Contraction
trough or Depression (blue shaded areas).
Real GDP
Business
peak
Trend line
Business
peak
Depression
or trough
Depression
or trough
Time
The Business Cycle
• Cycles are irregular
•Annual growth
rate of real GDP
•8
•Long-run growth rate
(approx. 3%)
•6
•4
•2
•0
•- 2
•1960 •1965 •1970 •1975 •1980 •1985 •1990 •1995 •2000 •2005 •2009
•Source: Economic Report of the President, various issues.
• Ups and downs characterize business activity.
• There has been an upward trend in real GDP in the
United States and other industrial nations.
Changes in Total (Aggregate) Spending in
the Economy, cause changes in total
(aggregate) production and employment
1.
2.
3.
4.
Households
Businesses
The Government
Foreigners
Goods and Services Markets
Payments $$
•Simple Case: all output is
purchased by the household
Businesses
•Nothing left for businesses,
government or foreigners
Resource Markets
Resources
Households
1. Spend their earned income
2. Biggest spenders
(7.1 of 10.2 trillion)
3. Expansion
4. Contraction
a. Increased spending
a. Decreased spending
b. larger output
b. smaller output
c. increased employment
c. decreased employment
d. more income
d. less income
•Next Case: households save
some of their income, output
is left over
•Businesses purchase left
over output, government or
foreigners still get none
Another
Circular
Flow
1. Investment spending
2. Borrow to buy capital
replace old and new machinery
3. Reasons to buy or invest
a. expected profits
b. economic activity
c. lower interest rates
•Next Case: not all output is
purchased by the household
or businesses
•something left for
government or foreigners
1. Second largest spender
2. Purchases goods and services
3. provides transfers
No goods or services received
Another
Circular
Flow
•Final Case: all output is not
purchased domestically
•Something left for
foreigners
1. Exports
Foreign purchases of US goods and services
2. Imports
US purchases of Foreign goods and services
Another
Circular
Flow
From the Circular Flow:
1. Savings – consumers not spending
2. Taxes - money not able to spend
3. Imports - money sent abroad
From the Circular Flow:
1. Investments –spending from Business
2. Government transfers - money not
earned by Households
3. Exports - money from abroad
The Multiplier
• The Multiplier:
A change in an injection (e.g. investment) leads to an
even larger change in output and employment.
• An injection comes from outside of the
circular flow. (non-household)
• Once it enters, the dollars are spent over and
over.
• The multiplier is the number by which the
change in spending is multiplied to obtain the
total increase.
• The size of the multiplier depends on
how much is spent of each increase.
• The greater this %, the greater the effect
The Multiplier
• Remember:
• injections will increase the size of the
multiplier;
• leakages will decrease the size of the
multiplier,
The Multiplier Principle
Expenditure
stage
Additional income
Additional consumption
Marginal propensity
to consume
(dollars)
(dollars)
Round 1
Round 2
Round 3
Round 4
Round 5
All others
1,000,000
750,000
562,500
421,875
316,406
949,219
750,000
562,500
3/4
3/4
421,875
316,406
237,305
711,914
3/4
3/4
3/4
3/4
Total
4,000,000
3,000,000
3/4
For simplicity (here) it is assumed that all additions to income are either spent domestically or saved.
• The multiplier concept is based upon the proportion of additional income
that households choose to spend (here assumed to be 75% = 3/4).
• Here, a $1,000,000 injection is spent, received as payment, saved and
spent, received as payment, saved and spent … etc. … until …
effectively, $4 million is spent in the economy.
Assume the people will spend .8 (80%) of a change in
their income and the change in business investment is
$10 (billion). Complete the table below. How much
will they save? ______
change in
income
change in
consumption
change in
savings
+ $10
8
2
2nd round
8
6.4
1.6
3rd round
6.4
5.1
1.3
4th round
5.1
4.1
1
5th round
4.1
3.3
.8
16.38
13.10
3.28
50
40
10
increase in
invest-ment of
$10 billion
all other rounds
Totals
Higher Spending
Means a Larger Multiplier
MPC
Size of
multiplier
9/10
4/5
3/4
2/3
1/2
1/3
10.0
5.0
4.0
3.0
2.0
1.5
• As the spending % increases more and more money of every
injection is spent (and so received as payment and then spent
again, received as payment and spent again, etc.).
• The effect is that for higher spending, higher multipliers
result, specifically the relationship follows this equation:
1
M = 1 - %spent
Calculating the effect of the multiplier:
change in the injection
% not spent (saved)
Change in investment
% saved
multiplier effect
$10
20%
________
$10
10%
________
$10
25%
________
$20
20%
________
•The phase of the business cycle where real GDP, or output,
reaches its maximum is the:
•a. limit
•b. trough
•c. peak
•d. expansion
•Money received by a household from the government for
which there is no work directly performed in return is:
•a. a surtax
•b. a payment-in-kind.
•c. a transfer payment.
•d. an income tax refund.
•Which of the following is a leakage from the
spending stream by households?
•a. saving
•b. a decrease in earned income.
•c. the receipt of transfer payments.
•d. borrowing from financial institutions.
•A decrease in interest rates would
•a.
have no effect on investment decisions
•b.
make investment projects less attractive.
•c.
make more investment projects attractive
•d.
make investment spending as stable as personal
consumption expenditures.
The 2 main categories of government expenditures are:
a. defense expenditures and tax refunds
b. purchases of goods and purchases of services
c. purchases of goods and services and transfer payments
d. income determined and non-income-determined
spending.
The multiplier effect is the change in:
a. income-determined spending generated by a change in total output.
b. total output generated by a change in income-determined spending.
c. total output generated by a change in non-income-determined
spending.
d. non-income-determined spending generated by a change in total
output