Transcript “Multiplied”?

A Quick Review in the Movies!!!
UNIT 3
NATIONAL INCOME AND PRICE DETERMINATION
Why do cities want the Superbowl?
Because an initial change in spending will set off a spending
chain that is magnified throughout the economy.
Example:
•
•
•
•
Bobby spends $100 on Jason’s product
Jason now has more income so he buys $100 of Nancy’s product
Nancy now has more income so she buys $100 of Tiffany’s product.
The result is an $300 increase in consumer spending
The Multiplier Effect shows how spending is
magnified in the economy.
3
Marginal Propensity to Consume (MPC)
•How much people consume rather than save when
there is an change in income.
•It is always expressed as a fraction (decimal).
MPC=
Change in Consumer Spending
Change in Income
Example:
Consumer spending goes up by 6 billion
Disposable income goes up by 10 billion
What is the MPC?
Means?
4
Marginal Propensity to Save (MPS)
•How much people save rather than consume when
there is an change in income.
•It is always expressed as a fraction (decimal)
MPS=
Change in Saving
Change in Income
Or….
MPS=1-MPC
5
MPC + MPS = 1
----------------------MPS = 1 - MPC
Why is this true?
Because people can either save or consume
The new disposable income they receive
6
Practice Problems
The Multiplier
It’s a simple concept…
The Multiplier in the real
world…
The federal government recently enacted the American Recovery and
Reinvestment Act of 2009. This “stimulus package” of $787 billion
was intended to spark job growth to reverse the worst recession since
the Great Depression.
How was this supposed to work?
The short answer is that $1 of spending in one area of the economy
multiplies into more than $1 of spending throughout the economy
Autonomous Change in Aggregate Spending
• This is the initial change in aggregate spending
before real GDP rises. It is the cause, not the
result, of the chain reaction.
• The multiplier is the ratio of the total change
in real GDP caused by AAS.
Multiplier = change in real GDP
change in AAS
The size of the multiplier will depend on the MPC.
The higher the MPC the higher the multiplier.
{In other words, the more money spent the greater
the impact the multiplier will have}
What do you need to know and
understand how the multiplier
works?
How is Spending “Multiplied”?
Assume the MPC is .5 for everyone
•Assume that when the Super Bowl comes to town
there is an increase of $100 in Ashley’s restaurant.
•Ashley now has $100 more income.
•She saves $50 and spends $50 at Carl’s Salon
•Carl now has $50 more income
•He saves $25 and spends $25 at Dan’s fruit stand
•Dan now has $25 more income.
This continues until every penny is spent or saved
Change in
GDP
= Multiplier x
Initial Change
in Spending
13
or
• Multiplier = Change in GDP
Change in Spending
*** I just made an algebraic change
If the MPC is .5 how much is the multiplier?
1
1
Simple
or 1 - MPC
MPS
Multiplier
=
•If the multiplier is 4, how much will an initial
increase of $5 in Government spending increase
the GDP?
•How much will a decrease of $3 in spending
decrease GDP?
Change in
GDP
= Multiplier x
initial change
in spending
15
The Multiplier Effect
Practice calculating the spending multiplier
1
1
Simple
or 1 - MPC
MPS
Multiplier
1. If MPC is .9, what is multiplier?
2. If MPC is .8, what is multiplier?
3. If MPC is .5, and consumption increased $2M.
How much will GDP increase?
4. If MPC is 0 and investment increases $2M.
How much will GDP increase?
=
Conclusion: As the Marginal Propensity to
Consume falls, the Multiplier Effect is less
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Did the stimulus help or hurt the economy.
APE 21
APE 21
APE 21
Smaller
The increase in GDP would be smaller if they held more money.
If we all spent ALL of our income or our change the spending
multiplier would be infinite..
APE 21
APE 21
-.90/.10= -9.0
-.80/.20= -4.0
-.75/.25= -3.0
APE 21
-4 (-.80/.20)
3 (1/.33)
-3 (-.75/.25)
If people begin to worry about their jobs and/or their
wealth (stocks, housing prices, etc) they will hold more
money which decreases the multiplier.
APE 21
If the multiplier is 5 the MPC is .80.
Tax multiplier= -.80/.20=-4
APE 21
MPC=Change in consumption/change in income
MPC=75/100=.75
Marginal Propensity to Consume
The consumption function is an equation showing how
an individual household’s consumer spending varies with
the household’s current disposable income.
Two factors can change Aggregate Consumption Function
• 1. Changes in expected future disposable
income
• 2. Changes in aggregate wealth
Duffka School of Economics
Investment Spending
Consumer spending is much larger than investment spending,
but booms and busts in investment spending tend to drive the
business cycle.
Most recessions originate as a fall in investment spending.
Investment Spending
• Planned Investment is
what firms intend to
undertake in a given
period but it will depend
on three (3) factors:
• 1- interest rates
• 2-expected future GDP
• 3- current level of
production capacity
Investment demand handout
Inventories
• Increase in inventories =investment spending
• Higher than anticipated inventories due to a
unplanned decrease in sales is known as
unplanned inventory investment.
• Investment (I) = I unplanned + I planned