multiplier analysis - deu.edu.trkisi.deu.edu.tr/serdar.ayan/macroeconomics/macroeconomics_6.pdf ·...

Demand-Side Equilibrium: Demand-Side Equilibrium: Demand-Side Equilibrium: Demand-Side Equilibrium: Multiplier AnalysisMultiplier AnalysisMultiplier AnalysisMultiplier Analysis

A definite ratio, to be called the A definite ratio, to be called the A definite ratio, to be called the A definite ratio, to be called the Multiplier, Multiplier, Multiplier, Multiplier, can be can be can be can be established between income and investment.established between income and investment.established between income and investment.established between income and investment.

JOHN MAYNARD KEYNESJOHN MAYNARD KEYNESJOHN MAYNARD KEYNESJOHN MAYNARD KEYNES

Asst. Prof. Dr. Serdar AYANAsst. Prof. Dr. Serdar AYANAsst. Prof. Dr. Serdar AYANAsst. Prof. Dr. Serdar AYAN

● GDP cannot be at its equilibrium if total spending differs from the value of output.

● If spending exceeds output, inventories fall and firms increase production.

● If output exceeds spending, inventories rise and firms reduce production.

● GDP cannot be at its equilibrium if total spending differs from the value of output.

● If spending exceeds output, inventories fall and firms increase production.

● If output exceeds spending, inventories rise and firms reduce production.

The Meaning of Equilibrium The Meaning of Equilibrium The Meaning of Equilibrium The Meaning of Equilibrium GDPGDPGDPGDPThe Meaning of Equilibrium The Meaning of Equilibrium The Meaning of Equilibrium The Meaning of Equilibrium GDPGDPGDPGDP

FIGUREFIGUREFIGUREFIGURE 1 1 1 1.... The Circular Flow The Circular Flow The Circular Flow The Circular Flow DiagramDiagramDiagramDiagram

FIGUREFIGUREFIGUREFIGURE 1 1 1 1.... The Circular Flow The Circular Flow The Circular Flow The Circular Flow DiagramDiagramDiagramDiagram

....

1111

3333

6666

5555

4444

2222

InvestorsInvestorsInvestorsInvestors

GovernmentGovernmentGovernmentGovernment

FirmsFirmsFirmsFirms(produce the(produce the(produce the(produce the

domestic product)domestic product)domestic product)domestic product)

ConsumersConsumersConsumersConsumers

Financial SystemFinancial SystemFinancial SystemFinancial SystemRest of theRest of theRest of theRest of the

WorldWorldWorldWorld

Saving (Saving (Saving (Saving (SSSS))))

Consumption (C)

Consumption (C)

Consumption (C)

Consumption (C)

Inve

stm

ent (

I)

Inve

stm

ent (

I)

Inve

stm

ent (

I)

Inve

stm

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I) CCCC + + + + IIII

Gov

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Gov

ernm

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Gov

ernm

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Gov

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CCCC + + + + IIII + + + + GGGGImports (

Imports (

Imports (

Imports (IMIMIMIM))))

Exports (

Exports (

Exports (

Exports (XXXX))))

CCCC + + + + IIII +

+ + + GGGG

+ + + +

TransfersTransfersTransfersTransfers

Disposable

Disposable

Disposable

Disposable Income (

Income (

Income (

Income (DIDIDIDI))))

TaxesTaxesTaxesTaxes

GrossGrossGrossGross

NationalNationalNationalNationalIncome (Income (Income (Income (YYYY))))

((((XXXX –––– IMIMIMIM) ) ) )

Purch

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(

Purch

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(

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(GGGG

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● The equilibrium level of GDP on the demand side is the one at which total spending equals production.

● In such a situation, firms find their inventories remaining at desired levels, so there is no incentive to change output or prices.

● The equilibrium level of GDP on the demand side is the one at which total spending equals production.

● In such a situation, firms find their inventories remaining at desired levels, so there is no incentive to change output or prices.

The Meaning of Equilibrium The Meaning of Equilibrium The Meaning of Equilibrium The Meaning of Equilibrium GDPGDPGDPGDPThe Meaning of Equilibrium The Meaning of Equilibrium The Meaning of Equilibrium The Meaning of Equilibrium GDPGDPGDPGDP

The Mechanics of Income The Mechanics of Income The Mechanics of Income The Mechanics of Income DeterminationDeterminationDeterminationDeterminationThe Mechanics of Income The Mechanics of Income The Mechanics of Income The Mechanics of Income DeterminationDeterminationDeterminationDetermination

● Constructing the total expenditure schedule♦ Expenditure Schedule = table showing the

relationship between GDP and total spending♦ Induced Investment = the part of investment

spending that rises when GDP rises, and falls when GDP falls.

● Constructing the total expenditure schedule♦ Expenditure Schedule = table showing the

relationship between GDP and total spending♦ Induced Investment = the part of investment

spending that rises when GDP rises, and falls when GDP falls.

TABLETABLETABLETABLE 1.1.1.1. The Determination of The Determination of The Determination of The Determination of Equilibrium OutputEquilibrium OutputEquilibrium OutputEquilibrium Output

TABLETABLETABLETABLE 1.1.1.1. The Determination of The Determination of The Determination of The Determination of Equilibrium OutputEquilibrium OutputEquilibrium OutputEquilibrium Output

FIGUREFIGUREFIGUREFIGURE 2 2 2 2.... Construction of the Construction of the Construction of the Construction of the Expenditure ScheduleExpenditure ScheduleExpenditure ScheduleExpenditure Schedule

FIGUREFIGUREFIGUREFIGURE 2 2 2 2.... Construction of the Construction of the Construction of the Construction of the Expenditure ScheduleExpenditure ScheduleExpenditure ScheduleExpenditure Schedule

....

G = $1,300 $1,300 $1,300 $1,300

I = $900 $900 $900 $900

C + + + + I + + + + G

C + + + + I + + + + G + ( + ( + ( + (X –––– IM) ) ) )

C + + + + I

C

7,200 7,200 7,200 7,200 6,800 6,800 6,800 6,800 6,400 6,400 6,400 6,400 6,000 6,000 6,000 6,000 5,600 5,600 5,600 5,600

6,000 6,000 6,000 6,000 6,100 6,100 6,100 6,100

4,800 4,800 4,800 4,800

Rea

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Real GDP Real GDP Real GDP Real GDP 5,200 5,200 5,200 5,200

3,900 3,900 3,900 3,900

X X X X ––––IM =IM =IM =IM = ––––$100 $100 $100 $100

● Both the expenditure table and the corresponding “income-expenditure diagram” or “45 degree line diagram” show the equilibrium level of GDP.

● All other levels of GDP are disequilibrium points, at which GDP will move in the direction of the equilibrium.

● Both the expenditure table and the corresponding “income-expenditure diagram” or “45 degree line diagram” show the equilibrium level of GDP.

● All other levels of GDP are disequilibrium points, at which GDP will move in the direction of the equilibrium.

The Mechanics of Income The Mechanics of Income The Mechanics of Income The Mechanics of Income DeterminationDeterminationDeterminationDeterminationThe Mechanics of Income The Mechanics of Income The Mechanics of Income The Mechanics of Income DeterminationDeterminationDeterminationDetermination

FIGUREFIGUREFIGUREFIGURE 3 3 3 3.... Income-Expenditure Income-Expenditure Income-Expenditure Income-Expenditure DiagramDiagramDiagramDiagram

FIGUREFIGUREFIGUREFIGURE 3 3 3 3.... Income-Expenditure Income-Expenditure Income-Expenditure Income-Expenditure DiagramDiagramDiagramDiagram

Spending exceeds Spending exceeds Spending exceeds Spending exceeds output output output output

Output exceeds spending Output exceeds spending Output exceeds spending Output exceeds spending

Equilibrium Equilibrium Equilibrium Equilibrium

6,000 6,000 6,000 6,000

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45454545°°°°

5,200 5,200 5,200 5,200 5,600 5,600 5,600 5,600 6,000 6,000 6,000 6,000 6,400 6,400 6,400 6,400 6,800 6,800 6,800 6,800 7,200 7,200 7,200 7,200 0 0 0 0

4,800 4,800 4,800 4,800

5,600 5,600 5,600 5,600

6,400 6,400 6,400 6,400

6,800 6,800 6,800 6,800

7,200 7,200 7,200 7,200


5,200 5,200 5,200 5,200

CCCC + IIII + GGGG + ((((XXXX –––– IIIIMMMM) ) ) )

E E E E

●↑ price level ⇒ ↓ consumption● Therefore, ↑ price level ⇒ ↓ total

expenditures and ↓ equilibrium GDP● Therefore, ↑ price level ⇒ ↓ equilibrium

level of real aggregate quantity demanded

●↑ price level ⇒ ↓ consumption● Therefore, ↑ price level ⇒ ↓ total

expenditures and ↓ equilibrium GDP● Therefore, ↑ price level ⇒ ↓ equilibrium

level of real aggregate quantity demanded

The Aggregate Demand The Aggregate Demand The Aggregate Demand The Aggregate Demand CurveCurveCurveCurveThe Aggregate Demand The Aggregate Demand The Aggregate Demand The Aggregate Demand CurveCurveCurveCurve

FIGUREFIGUREFIGUREFIGURE 4 4 4 4.... The Effect of the Price The Effect of the Price The Effect of the Price The Effect of the Price Level on Equilibrium ADLevel on Equilibrium ADLevel on Equilibrium ADLevel on Equilibrium AD

FIGUREFIGUREFIGUREFIGURE 4 4 4 4.... The Effect of the Price The Effect of the Price The Effect of the Price The Effect of the Price Level on Equilibrium ADLevel on Equilibrium ADLevel on Equilibrium ADLevel on Equilibrium AD

((((b) b) b) b)

Fall in PricFall in PricFall in PricFall in Price Level e Level e Level e Level

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Real GDP Real GDP Real GDP Real GDP

C0000 + + + + I + + + + G + ( + ( + ( + (X––––IM) ) ) )

Y0 0 0 0 Y2 2 2 2

((((a) a) a) a)

Rise in PricRise in PricRise in PricRise in Price Level e Level e Level e Level

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C0000 + + + + I + + + + G + ( + ( + ( + (X––––IM) ) ) )

Y0 0 0 0 Y1 1 1 1

45 45 45 45

45 45 45 45

45 45 45 45

45 45 45 45

C2222 + + + + I + + + + G + ( + ( + ( + (X––––IM) ) ) )

E0 0 0 0 E0 0 0 0

C1111 + + + + I + + + + G + ( + ( + ( + (X––––IM) ) ) ) E1 1 1 1

E2 2 2 2

The Aggregate Demand The Aggregate Demand The Aggregate Demand The Aggregate Demand CurveCurveCurveCurveThe Aggregate Demand The Aggregate Demand The Aggregate Demand The Aggregate Demand CurveCurveCurveCurve

● The negatively-sloped aggregate demand curve shows all the equilibria of price levels and GDP.

● Remember that any income-expenditure diagram is drawn for a specific price level.

● The negatively-sloped aggregate demand curve shows all the equilibria of price levels and GDP.

● Remember that any income-expenditure diagram is drawn for a specific price level.

FIGUREFIGUREFIGUREFIGURE 5 5 5 5.... The Aggregate The Aggregate The Aggregate The Aggregate Demand CurveDemand CurveDemand CurveDemand Curve

FIGUREFIGUREFIGUREFIGURE 5 5 5 5.... The Aggregate The Aggregate The Aggregate The Aggregate Demand CurveDemand CurveDemand CurveDemand Curve

E2 2 2 2

E0 0 0 0

E1 1 1 1

Pric

e Le

vel

Pric

e Le

vel

Pric

e Le

vel

Pric

e Le

vel


P1 1 1 1

P0 0 0 0

P2 2 2 2

Y2 2 2 2 Y0 0 0 0 Y1 1 1 1

● Equilibrium GDP may not = full-employment GDP.

● Recessionary gap: amount by which equilibrium GDP < potential GDP

● Inflationary gap: amount by which equilibrium GDP > potential GDP

● Equilibrium GDP may not = full-employment GDP.

● Recessionary gap: amount by which equilibrium GDP < potential GDP

● Inflationary gap: amount by which equilibrium GDP > potential GDP

Demand-Side Equilibrium Demand-Side Equilibrium Demand-Side Equilibrium Demand-Side Equilibrium and Full Employmentand Full Employmentand Full Employmentand Full EmploymentDemand-Side Equilibrium Demand-Side Equilibrium Demand-Side Equilibrium Demand-Side Equilibrium and Full Employmentand Full Employmentand Full Employmentand Full Employment

FIGUREFIGUREFIGUREFIGURE 6 6 6 6.... A Recessionary GapA Recessionary GapA Recessionary GapA Recessionary GapFIGUREFIGUREFIGUREFIGURE 6 6 6 6.... A Recessionary GapA Recessionary GapA Recessionary GapA Recessionary Gap

Recessionary gap Recessionary gap Recessionary gap Recessionary gap

CCCC + IIII + GGGG + ( ( ( (XXXX – IIIIMMMM) ) ) )

45454545°°°°

45454545°°°°

Potential Potential Potential Potential GDP GDP GDP GDP

7,000 7,000 7,000 7,000

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E E E E

F F F F

B B B B

FIGUREFIGUREFIGUREFIGURE 7 7 7 7.... An Inflationary GapAn Inflationary GapAn Inflationary GapAn Inflationary GapFIGUREFIGUREFIGUREFIGURE 7 7 7 7.... An Inflationary GapAn Inflationary GapAn Inflationary GapAn Inflationary Gap

Inflationary gap Inflationary gap Inflationary gap Inflationary gap

45454545°°°°

45454545°°°°

Potential Potential Potential Potential GDP GDP GDP GDP

8,000 8,000 8,000 8,000

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CCCC + IIII + GGGG + ( ( ( (XXXX – IIIIMMMM) ) ) )

F F F F

B B B B E E E E

The Coordination of Saving The Coordination of Saving The Coordination of Saving The Coordination of Saving and Investmentand Investmentand Investmentand InvestmentThe Coordination of Saving The Coordination of Saving The Coordination of Saving The Coordination of Saving and Investmentand Investmentand Investmentand Investment

● Equilibrium GDP = full employment only if saving out of full-employment incomes = investment

● Savers are not the same people as investors, so it is unlikely that this condition will hold.

● Equilibrium GDP = full employment only if saving out of full-employment incomes = investment

● Savers are not the same people as investors, so it is unlikely that this condition will hold.

FIGUREFIGUREFIGUREFIGURE 8 8 8 8.... A Simplified Circular A Simplified Circular A Simplified Circular A Simplified Circular FlowFlowFlowFlow

FIGUREFIGUREFIGUREFIGURE 8 8 8 8.... A Simplified Circular A Simplified Circular A Simplified Circular A Simplified Circular FlowFlowFlowFlow

1111

3333

InvestorsInvestorsInvestorsInvestors

ConsumersConsumersConsumersConsumers

Financial SystemFinancial SystemFinancial SystemFinancial System

Saving (Saving (Saving (Saving (SSSS))))

Consumption (

Consumption (

Consumption (

Consumption (CCCC))))

Inve

stm

ent (

I)

Inve

stm

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I)

Inve

stm

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I)

Inve

stm

ent (

I) CCCC + + + + IIII

CCCC + + + + IIII

YYYY

FirmsFirmsFirmsFirms(produce the(produce the(produce the(produce the

domestic product)domestic product)domestic product)domestic product)

2222

Changes on the Demand Changes on the Demand Changes on the Demand Changes on the Demand Side: Multiplier AnalysisSide: Multiplier AnalysisSide: Multiplier AnalysisSide: Multiplier AnalysisChanges on the Demand Changes on the Demand Changes on the Demand Changes on the Demand Side: Multiplier AnalysisSide: Multiplier AnalysisSide: Multiplier AnalysisSide: Multiplier Analysis

● Multiplier = ratio of the change in equilibrium GDP (Y) divided by the original change in spending that caused the change in GDP

● Multiplier = ratio of the change in equilibrium GDP (Y) divided by the original change in spending that caused the change in GDP

Changes on the Demand Changes on the Demand Changes on the Demand Changes on the Demand Side: Multiplier Analysis Side: Multiplier Analysis Side: Multiplier Analysis Side: Multiplier Analysis Changes on the Demand Changes on the Demand Changes on the Demand Changes on the Demand Side: Multiplier Analysis Side: Multiplier Analysis Side: Multiplier Analysis Side: Multiplier Analysis

● Demystifying the Multiplier: How It Works♦ The multiplier is greater than 1 because one

person’s spending is another person’s income.♦ ↑ spending ⇒ ↑ income♦ A portion of the increase in income is spent on

consumption, creating more income, which in turn creates more consumption spending, and so on.

● Demystifying the Multiplier: How It Works♦ The multiplier is greater than 1 because one

person’s spending is another person’s income.♦ ↑ spending ⇒ ↑ income♦ A portion of the increase in income is spent on

consumption, creating more income, which in turn creates more consumption spending, and so on.

TABLETABLETABLETABLE 4 4 4 4.... The Multiplier The Multiplier The Multiplier The Multiplier Spending ChainSpending ChainSpending ChainSpending Chain

TABLETABLETABLETABLE 4 4 4 4.... The Multiplier The Multiplier The Multiplier The Multiplier Spending ChainSpending ChainSpending ChainSpending Chain

FIGUREFIGUREFIGUREFIGURE 10 10 10 10.... How the Multiplier How the Multiplier How the Multiplier How the Multiplier BuildsBuildsBuildsBuilds

FIGUREFIGUREFIGUREFIGURE 10 10 10 10.... How the Multiplier How the Multiplier How the Multiplier How the Multiplier BuildsBuildsBuildsBuilds

Spending Round Spending Round Spending Round Spending Round

20 20 20 20 15 15 15 15 10 10 10 10 8 8 8 8 6 6 6 6 4 4 4 4 2 2 2 2

Cum

ulat

ive

Spen

ding

Tot

al

Cum

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ive

Spen

ding

Tot

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Cum

ulat

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Spen

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Tot

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Cum

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Spen

ding

Tot

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$4.0 $4.0 $4.0 $4.0

2.0 2.0 2.0 2.0

3.0 3.0 3.0 3.0

1.0 1.0 1.0 1.0

0 0 0 0


● Algebraic Statement of the Multiplier♦ Multiplier = 1 ÷ (1 - MPC)♦ The MPC has been estimated to be about 0.9,

implying that the multiplier is 10. ♦ In fact, the multiplier is < 2.

● Algebraic Statement of the Multiplier♦ Multiplier = 1 ÷ (1 - MPC)♦ The MPC has been estimated to be about 0.9,

implying that the multiplier is 10. ♦ In fact, the multiplier is < 2.

● Algebraic Statement of the Multiplier♦ Factors that reduce the size of the multiplier

■International trade■Inflation■Income taxation■Financial system

● Algebraic Statement of the Multiplier♦ Factors that reduce the size of the multiplier

■International trade■Inflation■Income taxation■Financial system


The Multiplier Is a General The Multiplier Is a General The Multiplier Is a General The Multiplier Is a General ConceptConceptConceptConceptThe Multiplier Is a General The Multiplier Is a General The Multiplier Is a General The Multiplier Is a General ConceptConceptConceptConcept

● An autonomous change in consumer spending (caused by something other than an increase in income) shifts the consumption function and has a multiplier effect, just the same as a change in I does.

● An autonomous change in consumer spending (caused by something other than an increase in income) shifts the consumption function and has a multiplier effect, just the same as a change in I does.

●Other multiplier effects:♦ A change in G has the same multiplier effect as

a change in I or a change in autonomous C.♦ The multiplier effect of a change in (X - IM) is

the same as for the other components of spending.

♦ Consequently, trade links the GDPs of the major economies.

●Other multiplier effects:♦ A change in G has the same multiplier effect as

a change in I or a change in autonomous C.♦ The multiplier effect of a change in (X - IM) is

the same as for the other components of spending.

♦ Consequently, trade links the GDPs of the major economies.


●↑ GDP in a foreign country ⇒ ↑ its imports, a portion of which are exports from the U.S.

● The growth in U.S. exports has a multiplier effect, raising GDP in the U.S.

● Booms and recessions tend to be transmitted across national borders.

●↑ GDP in a foreign country ⇒ ↑ its imports, a portion of which are exports from the U.S.

● The growth in U.S. exports has a multiplier effect, raising GDP in the U.S.

● Booms and recessions tend to be transmitted across national borders.


The Multiplier and the The Multiplier and the The Multiplier and the The Multiplier and the Aggregate Demand CurveAggregate Demand CurveAggregate Demand CurveAggregate Demand CurveThe Multiplier and the The Multiplier and the The Multiplier and the The Multiplier and the Aggregate Demand CurveAggregate Demand CurveAggregate Demand CurveAggregate Demand Curve

●∆ autonomous spending ⇒ horizontal shift of the AD curve by an amount given by the oversimplified multiplier formula.

●∆ autonomous spending ⇒ horizontal shift of the AD curve by an amount given by the oversimplified multiplier formula.

FIGUREFIGUREFIGUREFIGURE 12 12 12 12.... Two Views of the Two Views of the Two Views of the Two Views of the MultiplierMultiplierMultiplierMultiplier

FIGUREFIGUREFIGUREFIGURE 12 12 12 12.... Two Views of the Two Views of the Two Views of the Two Views of the MultiplierMultiplierMultiplierMultiplier

45454545°

C C C C ++++ I I I I1111 ++++ G G G G ++++ (X (X (X (X –––– IIIIMMMM ) ) ) )

$200 billion $200 billion $200 billion $200 billion

C C C C ++++ I I I I0000 ++++ G G G G ++++ ((((X X X X –––– IIIIMMMM ) ) ) )

0 0 0 0 6,000 6,000 6,000 6,000

100 100 100 100

Pric

e Le

vel

Pric

e Le

vel

Pric

e Le

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Pric

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6,800 6,800 6,800 6,800

6,800 6,800 6,800 6,800 6,000 6,000 6,000 6,000


((((I = $1,100) = $1,100) = $1,100) = $1,100) DDDD1 1 1 1

DDDD1 1 1 1

((((I = $900) = $900) = $900) = $900) DDDD0 0 0 0

DDDD0 0 0 0

EEEE0 0 0 0

EEEE0 0 0 0

EEEE1 1 1 1

EEEE1 1 1 1

The Simple Algebra of Income Determination

and the Multiplier

Simple Algebra of Income Simple Algebra of Income Simple Algebra of Income Simple Algebra of Income Determination & MultiplierDetermination & MultiplierDetermination & MultiplierDetermination & MultiplierSimple Algebra of Income Simple Algebra of Income Simple Algebra of Income Simple Algebra of Income Determination & MultiplierDetermination & MultiplierDetermination & MultiplierDetermination & Multiplier

● All of the relationships discussed can be represented in simple algebra.

● All of the relationships discussed can be represented in simple algebra.


● Consumption function: C = a + b(DI)♦ Positive linear relationship between C and DI♦ a = autonomous consumption, determined by

factors aside from DI♦ b = marginal propensity to consume = ∆C/ ∆DI

♦ b(DI) = induced consumption, determined by DI

● Consumption function: C = a + b(DI)♦ Positive linear relationship between C and DI♦ a = autonomous consumption, determined by

factors aside from DI♦ b = marginal propensity to consume = ∆C/ ∆DI

♦ b(DI) = induced consumption, determined by DI


● Equilibrium Y = C + I + G + (X - IM), so Equilibrium Y = a + b(DI) + I + G + (X - IM)

● Since DI = Y - T, Equilibrium Y = a + b(Y - T) + I + G + (X - IM)

● Therefore Equilibrium Y = a + bY - bT + I + G + (X - IM)

● Equilibrium Y = C + I + G + (X - IM), so Equilibrium Y = a + b(DI) + I + G + (X - IM)

● Since DI = Y - T, Equilibrium Y = a + b(Y - T) + I + G + (X - IM)

● Therefore Equilibrium Y = a + bY - bT + I + G + (X - IM)


● Then solve for Y: Equilibrium Y = [a - bT + I + G + (X - IM)] / (1 - b)

● Then solve for Y: Equilibrium Y = [a - bT + I + G + (X - IM)] / (1 - b)

multiplier analysis - deu.edu.trkisi.deu.edu.tr/serdar.ayan/macroeconomics/macroeconomics_6.pdf ·...

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