Transcript Aggregate Expenditures: The multiplier, net exports and government

Aggregate Expenditures:
The multiplier
Unit 3
Krugman Section 4 Module 21
Rationale of the Multiplier
 The economy has continuous flows of
expenditure & income—ripple effect
 Income received by person A comes from $
spent from person B.
 The fraction of the change in income that
is spent is called the MPC
 The fraction of the change in income that
is saved is called the MPS
The Multiplier Effect
 Small change in investment leads to a
large change in output and income.
 The multiplier determines how large the
change will be
 Multiplier = change in GDPr / initial change
in spending
 Ex. A $5 billion change in Ig led to a $20
billion change in GDP.
 What is the multiplier?
4
Multiplier & Marginal
Propensities
 The size of the MPC and the multiplier
are directly related
 The size of the MPS & the multiplier are
inversely related
 Spending Multiplier
 M = 1 / MPS
 or
 M = 1 / (1-MPC)
 Tax Multiplier
 -MPC/MPS
 OR -MPC/ (1-MPC)
 **note the negative sign (when the G taxes, we
have less DI = less C)
Significance of the
Multiplier
 A small change in investment plans or
consumption savings plans can trigger a
much larger change in the equilibrium
level of GDP
Magic of the Multiplier
Packet
Check for understanding:
What could happen to C, Savings
and/or DIg? The multiplier?
 1. The threat of war, leads the public to
expect future shortages of durables. (C,S,M)
 2. A decline in the real interest rate. (all)
 3. A sharp, sustained decline in stock prices.
(C,S,M)
 4. The development of a cheaper method of
manufacturing computer chips. (Ig,M)
 5. A sizable increase in the retirement age for
collecting social security benefits. (C,S,M)
 6. The expectation of an increase in the CPI
for the next two years. (C,S,M)
 7. The overall feeling of the nation is one of
optimism. (all)
 8. An increase in the federal income tax.
(C,S,M)
 1. The threat of war, leads the public to expect future
shortages of durables. (C,S)
 C increase S decrease
 Multiplier would increase
 2. A decline in the real interest rate. (all)
 Ig increase (movement) C increase S decrease
 Multiplier would increase
 3. A sharp, sustained decline in stock prices. (C, S)
 C decrease S increase
 Multiplier would decrease
 4. The development of a cheaper method of manufacturing
computer chips. (Ig)
 Ig increase (technology)
 Multiplier would increase
 5. A sizable increase in the retirement age for collecting
social security benefits. (C,S)
 C decrease S increase
 Multiplier would decrease
 6. The expectation of an increase in the CPI for the next two
years. (C,S)
 C increase S decrease
 Multiplier would increase
 7. The overall feeling of the nation is one of optimism. (all)
 C increase S decrease Ig increase
 Multiplier would increase
 8. An increase in the federal income tax. (C,S)
 C decrease S decrease
 **the exception to the increase of one means the decrease of the
other**
 Multiplier would decrease