Syllabus Requirement: The circular flow of income, the concepts of leakages and injections, and a general awareness of the multiplier effect. Lesson Objectives: understand what is meant by circular flow of income; show a general awareness of the concepts of leakages and injections and the multiplier effect. Reading: OCR AS Econ 121-122 BizEd Powerpoint http://www.bized.co.uk/educators/he/pearson/models/circular.ppt#316,1,Slide 1

Syllabus Requirement: The circular flow of income, the concepts of leakages and injections, and a general awareness of the multiplier effect. Lesson Objectives: All: should have a general awareness of the multiplier effect in the context of the circular flow of income Most: should understand the concept of the multiplier, be able to calculate it and appreciate its relevance in a practical situation Some: will be able to analyse the different influences on the size and impact of the multiplier

Injections increase the value of the goods and services in the economy (National Income) Withdrawals reduce the value of the goods and services in the economy (National Income) What is the SIZE OF THE IMPACT of any of these on the National Income /GDP?

How do we measure the final impact on the National Income? What happens when there is an injection into this circular flow of income? How do we measure the final impact on the National Income? Discuss what would happen if, for example, the government built a new college for Rawlins (ie it increased spending on education) Autonomous Injection Eg Gov increased G by spending £20m on a new college for us. What impact would this have on the economy?

What would the value of the final impact be?

Carrissa – the owner of Car Sales Showroom uses some of the extra income to go on holiday Thomas – the Travel Agent uses some of his extra income to buy new golf clubs I use my hard earned savings to buy a new car (£20,000) £ Gilly – the owner of Golf Shop uses some of her extra income to spend a weekend in Health Spa The initial injection of £20,000 spending has led to a much greater additional income/ spending as it circulates around the economy but how much greater? What influences the size of the impact? Haji – the Health Spa owner uses some of his extra income to take the family to a Theme Park It largely depends upon how much of the additional income earned people put back into the economy in spending

THE MULTIPLIER EFFECT – a few facts: The MULTIPLIER EFFECT is the final impact any given autonomous increase in spending will have on Aggregate Demand (Circular Flow of National Income) as the additional spending continues to circulate around the economy. The size of the effect can be calculated using a equation = the Multiplier Equation – (there is a simple multiplier and a complex multiplier) Simple Multiplier = 1/mps Complex Multiplier = 1/mpw Change to National Income = Initial injection x multiplier. Eg if there is an initial injection of £10m into the economy and the mutltplier is 2.5 then the resulting change to national income = £10m x 2 = £25m As the additional spending circulates to other members of the economy the size of the additions get smaller as taxation, savings and imports (leakages) reduce the impact of that additional spending. It causes a shift to the right in the Aggregate Demand Curve (on a diagram)

The size of the multiplier depends upon the extent to which any additional income received is spent on goods and services produced in this country. This is known as the MARGINAL PROPENSITY to CONSUME (mpc) The simple multiplier is calculated by the equation 1 1-mpc 1 mps or Eg: if on average someone spends 80% of any additional income they get on goods and services in this country then the MP to consume = 0.8 The multiplier effect = 1÷ (1-0.8) = 1 ÷ 0.2 = 5 So an initial injection of £10,000 would result in an increase of £50,000 of income into the economy The larger the propensity to consume the greater the multiplier effect will be.

What could the different sources of that initial injection be in our economy? Discuss 3 possible sources Government Spending, eg building new schools or increase welfare payments Investment, eg Firms buying new equipment or building a new office block Greater Exports, eg UK firms sells more cars abroad, or more foreign visitors come to the UK What could the different reasons be for not spending additional income on goods and services produced in our economy? Savings Imports Taxation (withdrawls or leakages from the circular flow of income)

Eg if on average someone spends 80% of any additional income they get and 20% is saved then the MP to consume = 0.8 and MP to save = 0.2 HOWEVER, in a more complex, open economy then ‘leakages’ might also occur from TAXATION or IMPORTS so these must also be taken into consideration. It can be calculated using the complex equation for the Multiplier = 1/mpw [where w is the propensity for spending to be withdrawn/leak from the economy. Note: MPW = MPS(save) + MRT (rate of taxation) + MPM (import) Note: The multiplier effect also works in reverse, so any leakage from the circular flow will result in a greater fall in additional spending.

Calculate the impact on the economy of the following: The government spends £10m on a new school and the mpc is 0.7 Net exports increase by £5m and the mpc is 0.6 A firm borrows £500,000 money to buy new machinery. The economy on average has Taxation Rate = 20%, Savings Rate = 10% and Imports = 20% How much would the Government need to inject into the economy if it wanted to create a £100m increase in national income if the mpc was 0.8? The current Government wants the economy to grow but is cutting back on spending and increasing taxation – how do they expect the growth to occur? To what extent do you feel it is the government’s job to stimulate economic growth? Discuss this in 2s/3s and jot down your ideas Multiplier is 1 ÷ 0.3 = 3.3 so impact would be £10m x 3.3 = £33m Multiplier is 1 ÷ 0.4 = 2.5 so impact would be £5m x 2.5 = £12.5m Mpc is 0.5 and therefore the Multiplier is 2 so impact would be £1m For final impact to be £100m and the Multiplier is 5, then initial injection would need to have been £20m

Circular Flow of Income Firms Households Circular Flow of Income Withdrawls/ Leakages Injections Gov Spending Taxation Investment Savings Exports Imports Injections increase the value of the goods and services in the economy (National Income) Withdrawals/Leakages reduce the value of the goods and services in the economy (National Income)

Work in pairs to discuss and suggest how these statements should be completed: The multiplier effect is best described as ………………. The size of the multiplier can be calculated using the equation ……. The marginal propensity to consume is ……………………….. Three ways the size of the impact the multiplier effect would be reduced are…….. When you are confident of the answers join another pair to check your answers

Syllabus Requirement: The circular flow of income, the concepts of leakages and injections, and a general awareness of the multiplier effect. Lesson Objectives: All: should have a general awareness of the multiplier effect in the context of the circular flow of income 1 MINUTE TO JOT DOWN WHAT THE MULTIPLIER EFFECT IS CHECK IT WITH THE PEOPLE AROUND YOU Most: should understand the concept of the multiplier, be able to calculate it and appreciate its relevance in a practical situation Some: will be able to analyse the different influences on the size and impact of the multiplier

Studywork: READING: Peter Smith – Pgs 132-133 – The Multiplier SJ Grant – Pg 250 Tutor2U Notes on Multiplier http://tutor2u.net/economics/revision-notes/as-macro-multiplier-accelerator.html (Do not concern yourself with the Accelerator model, at this stage) BizEd Powerpoint http://www.bized.co.uk/educators/he/pearson/models/circular.ppt#316,1,Slide 1 WE WILL BEGIN NEXT LESSON WITH A SHORT TEST ON THE MULTIPLIER

Definition An initial change in aggregate demand will lead to greater increase in the final level of equilibrium national income.

WHY? Injections of demand into the circular flow of income stimulate further rounds of expenditure. “one person’s spending is another’s income” – and this can lead to a much bigger effect on equilibrium output and employment.

Example: An overseas company decides to build a new production plant in the UK. This creates a £300 million increase in business capital investment

This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are purchased will experience an increase in their incomes and profits. If they in turn, collectively spend about 60% of that additional income, then £180m will be added to the incomes of others. At this point, total income has grown by (£300m + (0.6 x £300m).

The sum will continue to increase as the producers of the additional goods and services gain an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be (£300m + (0.6 x £300m) + (0.6 x £180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

Therefore the Marginal Propensity to Consume. What affects the size of the multiplier? The size of the multiplier depends on how much of an increase in income is spent in the UK economy. Therefore the Marginal Propensity to Consume. For example if the MPC is 0.8 it means 80% of the increase in income is spent.

The MPC This is affected by: MPS – the marginal propensity to save MRT – the marginal rate of taxation MPM – the marginal propensity to import

The final Increase in Aggregate Demand (the multiplier effect) depends upon the extent to which: any additional income is spent or saved how much the Gov takes in taxation how much of the additional income is spent in imports The extent of the tendency for the additional income to continue to circulate as spending or be withdrawn is known as the MARGINAL PROPENSITY to CONSUME or WITHDRAW (save/tax/import). Eg if on average someone spends 80% of any additional income they get and 20% is saved then the MP to consume = 0.8 and MP to save = 0.2 The larger the propensity to consume the greater the multiplier effect will be. It can be calculated using the equation Multiplier = 1/mpw or 1/(1-mpc)