THE MULTIPLIER UNDERSTAND THE MULTIPLIER EFFECT BY ANALYZING A REAL WORLD EXAMPLE DEMONSTRATE UNDERSTANDING OF HOW THE MPC AND MPS ARE USED TO CALCULATE.

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Presentation transcript:

THE MULTIPLIER UNDERSTAND THE MULTIPLIER EFFECT BY ANALYZING A REAL WORLD EXAMPLE DEMONSTRATE UNDERSTANDING OF HOW THE MPC AND MPS ARE USED TO CALCULATE THE MULTIPLIER

WHAT WOULD BE THE RIPPLE EFFECT OF…

EFFECTS… More jobs More cars More consumption (materials needed for the cars) More income (quantity of wages increase) Household consumption goes up) Product markets stronger Firms produce more Firms hire more Households invest more Aggregate output increases!!!! REAL GDP increases!!!

INVESTMENT IS MULTIPLIED Much more than the $1 B USD investment from the firm; translated into EXPONENTIALLY more aggregate output/GDP We call this diffusion of wealth the MULTIPLIER EFFECT Formally: the ratio of the total change in real GDP caused by an autonomous change in aggregate spending (Tesla Corporate HQ) to the size of that autonomous change 1. Investment happened first (autonomous, initial change in spending) 2. Real GDP increases (directly resulting from new aggregate spending) 3. Real GDP increase causes chain reaction (circular flow diffusion of $) This change in spending can result from any component of Expenditure Approach C + I + G + Nx = Y By how much? We will see soon…

KEYNESIAN MODEL ASSUMPTIONS (4) 1.Producers are willing to supply additional output at a fixed price 1.$1 B investment equates to $1 B in output without driving up overall price level Ultimately, changes in overall spending translate into changes in aggregate output in terms of Real GDP (C + I + G + Nx = Y) 2. Take interest rate as given 3. No government spending and no taxes…see why shortly 4. Exports and imports are zero So, $1 B spent by households on new homes will result in an immediate $1 B increase in aggregate output/real GDP….but…

MULTIPLIERS PROPENSITIES

CHANGES IN DISPOSABLE INCOME Examine marginally, from $ to $ So, we know that a change in spending will result in more wages, after-tax income (DI) Marginal Propensity to Consume (MPC): the fraction of any change in consumption spending resulting from disposable income (DI) rising of falling MPC = change in consumer spending/change in disposable income MPC = ΔCS Ex: Pay-check of $100—spend $30, save $70 ΔDI MPC = 30/100 =.3 Always between 0 and 1

CHANGES IN DISPOSABLE INCOME Marginal Propensity to Save (MPS): fraction of an additional dollar of disposable income that is saved MPS = change in savings/change in disposable income MPS = ΔS Ex: Pay-check of $100—spend $30, ΔDI MPS = 70/100 =.7 OR… MPS = 1 − MPC (1 −.3 =.7 MPS) Remember, we can assume the spending will ALWAYS increase real GDP and disposable income because there are NO TAXES and NO INTERNATIONAL TRADE $1 in investment always yields a $1 increase in real GDP and $1 in DI

SPENDING MULTIPLIER Formula: 1 1 MPS or (1−MPC) Ex: MPC =.8 MPS =.2 Multiplier = or 1/5 or 5 = Multiplier Calculate: Spending Multiplier Multiplier = ? MPC =.9 MPC =.8 MPC =.5 MPC = 0

ANSWERS Multiplier = ? MPC =.910 MPC =.85 MPC =.52 MPC = 01