Equilibrium GDP and the Multiplier Effect

Aggregate Expenditures The total amount spent on final goods and services. AE consists of (C) consumption + (Ig) Gross Investment. AE = C + Ig

Equilibrium GDP The level at which the total quantity of goods produced equals the total quantity purchased. There is no surplus or shortage of goods. This means no unplanned changes in inventory. Below equilibrium GDP, there would be upward pressure on employment, output, and income. Above equilibrium, the opposite.

Graphical Analysis

Savings Equals Planned Investment Savings (S) and Planned/Gross Investment (Ig) are equal at equilibrium GDP. Savings is a leakage, or a withdrawl of spending. but, it can also be thought of as an injection. As an injection, savings essentially results in Gross Investment, which increases Income GDP.

The Multiplier Effect The multiplier effect shows that an initial change in spending can cause a larger change in DI and output or GDP. The multiplier determines how much larger that change will be. It measures the effect that any change in expenditure (G, C, Ig, or Xn) will have on GDP.

The Multiplier Effect Multiplier = Delta GDP / Delta Spending Or… Change in GDP = Multiplier x Delta Spending When Person A spends his money, it becomes person B's income. Then person B will go spend their income, which then becomes person C's money, etc. The cycle repeats, but because of the tendency to save, the amount spent in each cycle is less and less.

The Multiplier and Marginal Propensities The higher the MPC (thus, lower MPS), the larger the multiplier because the multiplier is equal to (1 / MPS) If the multiplier is equal to the reciprocal of the marginal propensity to save, the greater the marginal propensity to save, the smaller the multiplier, and vice versa. High MPC = High Multiplier.

Significance of the Multiplier Small changes in consumption and savings can trigger large changed in GDP. For countries that have a high MPC, this can create large boom and bust business cycles. There is also a complex multiplier that includes other leakages besides savings. These include taxes and imports.

Test Preparation Complete Questions 9, 10, and 17 on pages 223 and 224.