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) Assume producers are willing to supply additional output at a fixed price

2) Take the interest rate as given 3) Assume there is no government spending

and taxes (no taxes)4) 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/macroeconomics2/keynesianthought/keynesiancross.swf

Works Cited

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.