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Multiplication, Net Exports, and Government. I. Multiplier  Multiplier effect: a change in a component of agg expenditures leads to a larger change in.

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Presentation on theme: "Multiplication, Net Exports, and Government. I. Multiplier  Multiplier effect: a change in a component of agg expenditures leads to a larger change in."— Presentation transcript:

1 Multiplication, Net Exports, and Government

2 I. Multiplier  Multiplier effect: a change in a component of agg expenditures leads to a larger change in equilibrium GDP  Multiplier = change rGDP/initial change in spending  1) initial change usually investment (more volatile), but can be C,G, I, X  2) initial change: up or downshift in agg expend schedule due to up or downshift in component  3) multiplier can be negative

3 Source of Multiplication  1) repetitive, continuous flow of money  2) change income  fractional, same direction change in S and C   diminishing spending chain  ∆I  ∆wage, rent, interest, profit (spending and receiving income sides same coin)  Multiplication ends when ∆I matched by exactly offsetting S: corrects disequilibrium

4 MPC and MPS  Amount of multiplication necessary to recreate equilibrium determined by MPC and MPS  Multiplier = 1/MPS  MPS + MPC = 1  Multipliers = 1/(1-MPC)

5 Significance and Generalization  Multiplier creates larger fluctuations in economy from biz decisions: greater booms, greater busts  Simple multiplier: leakage only into savings (MPS of.05 = 20x)  Complex: leakage into taxes, imports (“fraction of the change in income which leaks, or is diverted, from the income- expenditure stream”); estimated at 2x

6 II. Trade and Equilibrium Output  C + I = private closed economy agg expend  C + I + (X-M)= private open economy  Net exports increase agg expenditure beyond what closed is capable of, so GDP up; net imports reduce agg ex below closed level, so GDP down  HOWEVER…

7  AS determined by input prices  Int’l trade generally increases efficiency   lower costs of production (of all resources, including investment capital (“money” is the single largest traded “good”))   greater output  Therefore, GDP higher in open economy  Also, int’l trade increases international incomes, therefore higher levels of exports (partly offsets lower GDP from imports)  Empirical evidence: “beggar-thy-neighbor” tariff wars of 1920s-30s

8 Exchange rates  Depreciation: dollar losing value (inflation) –Effect on net exports?  Appreciation: dollar gaining value (dis- or deflation) –Effect on net exports?  Effect on GDP? –Where are we on the curve?

9 III. Government  C + I + G + (X-M)  1) Continue simplified investment and net export schedules  2) G no effect on private spending  3) Assume tax revenue entirely personal taxes; DI

10 Spend and Tax  G spending increases agg expenditures and equilibrium GDP by a multiplier  G is an injection offsetting S and M –No, that’s not what I mean  G taxing reduces ae and eGDP by a multiplier, but indirectly by reducing DI  C; tax multiplier = tax x MPC  G taxes are a leakage  Tax cuts increase ae and eGDP, but less than an increase in spending

11 Balanced Budget Multiplier  $20 B in spending + $20 B in higher taxes  Increase spending: AE increases by full $20 B  Increase taxes: AE decreases by 20 x MPC= 20(.95)= 19  Net ∆ AE = 1  1 x (1/1-.95) = $20 B ∆ GDP  Balanced budget multiplier is always 1


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