1. AE with Xn & G, The Multiplier
[C+Ig] (Closed Economy)
[C+Ig+G+Xn] (Open Economy) S
AE3 (C+Ig+G+Xn) (Complex Economy) [Open & mixed]
(AE3)630
AE2 (C+Ig+Xn) (Open & Private) [X(40)-M(20)]
(AE2)550
+20 G
AE1(C+Ig)[Basic Economy][Private(no G)&Closed(no X or M)] S
+20 Xn
(AE1)470
Consumption
AE(C+Ig2)
+20 Ig
AE(C+Ig1)
C=390
AE(C+Ig)
+80
+80
+80
10 Ig
Real GDP
Real GDP
YR Y*

2. In A Perfect World…
AE could be understood in the context of closed economy. And any change in consumption would cause an equal change in real GDP. But its not that way.

3. In a closed economy, equilibrium real GDP will change in response to changes in either investments or consumption.
C + Ig
$530
510
490
470
450
430
410
390
370
Consumption 45 o o
Real GDP

4. But in the real world the AE is determined by spending on everything (C, Ig, G, & Xn) AE = [C + Ig + G + Xn]
C + Ig + Xn + G
C + Ig + Xn
C + Ig
Consumption (billions of dollars) 45 o o
550
Real GDP (billions of dollars)

5. Complicating this more is the fact that an change in AE will lead to a greater change in real GDP.
C + Ig + Xn + G
C + Ig + Xn
WHY?
C + Ig
Consumption (billions of dollars)
$20 billion in Xn 45 o o
550
Real GDP (billions of dollars)
$80 billion

6. Let’s Go To Padre Island and Party With The Multiplier
These are
LSU
students
At Padre.
UT student
During spring break, college students like to head to South Padre Island. Like a designated drive, the “multiplier” goes along to.
With dollars in their pockets, the students spend money on food, drink, motel rooms, dance clubs, etc. These dollars raise total income on the island by some multiple of itself.
College students buy pizzas, beer, and sodas. The people who sell all the pizza, soda/beer, and rooms find their incomes increasing. They spend some of the increase and they save some (MPC/MPS). The part spent (consumed) generates additional income for others, who will spend some and save some..
If students spend $8 million on South Padre Island and MPC is .60, then the economy of the Island will increase by $20 million.
Multiplier = ___1___ (Multiplier x $8 million = $20 million)
1-MPC

7. Change in GDP[80] = Multiplier[4] x change in expenditures [20]
THE MULTIPLIER EFFECT
A change in AE leads to a larger change in equilibrium real GDP. “Equilibrium GDP will increase by a “multiple of the multiplier.”
Multiplier [4] =
Change in Y (real GDP) [80]
Initial Change in E (expenitures)[20] Or
Change in GDP[80] = Multiplier[4] x change in expenditures [20]

8. Three things to remember about the multiplier;
The multiplier will affect, investment spending, net exports, and government purchases.
The change in spending will result in an upward or downward shift in the AE schedule.
The multiplier effect works in both directions (shifts of the AE schedule.)

9. What’s does it all mean Basal?
The economy is composed of continuous flows of expenditures and income, thus an initial change in spending will set off a spending chain reaction, leading to greater levels of real GDP.

10. Inverse relationship between MPS & Multiplier
Since the multiplier effect is determined by MPC (how much of our new money we consume in the economy), the smaller the MPS the greater the multiplier.
Inverse relationship between MPS & Multiplier
MPS Multiplier

11. MPC 1/MPS = Me
.90 1/.10 = 10
.80 1/.20 = 5
.75 1/.25 = 4
.60 1/.40 = 2.5
.50 1/.50 = 2
Multiplier = 1/MPS Or
Multiplier = 1/1-MPC

12. initial increase in G, Ig, Xn ($10B)
The Multiplier Effect
1($1) 1 or
Me=4 =
MPS(.25)
1 - MPC
(.75) x =
initial increase in G, Ig, Xn ($10B)
Change in GDP ($40B)
Me(4) Me
MPC .9 .8
.75
.60 .5 10 5 4
2.5 2

13. AE = C + Ig + Xn Positive if exports[25] > imports[20]
INTERNATIONAL TRADE:
Net exports (X – M) can be either
positive or negative
Private-Open
Positive if exports[25] > imports[20]
Negative if imports[25] > exports[20]
Like consumption and investment, exports (X) add to the nation’s real GDP. Thus, positive net exports must be added as a component of the AE.
AE = C + Ig + Xn
Other things equal, positive net exports shift the AE schedule upward and increases real GDP.

14. What is the affect on GDP?
MPC=.75
X = 25
M = 20
What is the affect on GDP?
510
490
470
450
430
AE with Positive
Net Exports[$5 x 4 = $20]
C + Ig + Xn1
C + Ig
AE(C+Ig+Xn)(billions of dollars)
+5 Xn 45 o o
Real domestic product, GDP (billions of dollars) +5 -5
(billions of dollars)
Net Exports, Xn
Real GDP

15. What is the affect on GDP?
MPC=.75
X of 20
M of 25
What is the affect on GDP?
510
490
470
450
430
AE with Negative
Xn[-$5 x 4 = -$20]
C + Ig
C + Ig + Xn2
AE(C+Ig+Xn) (billions 45 o o
Real domestic product, GDP (billions of dollars) +5 -5
(billions of dollars)
Net Exports, Xn
Real GDP

16. GLOBAL PERSPECTIVE NET EXPORTS OF GOODS, 2005 Negative Net Exports
Positive Net Exports
Canada
France
Germany
Italy
Japan
United Kingdom
United States
-400
-140
-100
-60
-20 20 60
100
Billions of Dollars
Source: World Trade Organization

17. Things Abroad That Can Affect Xn
1. Prosperity Abroad; the more prosperous our trading partners the more then can buy from us.
2. Tariffs; restrictions on
imports stimulate a domestic
economy.
3. Exchange Rates;
depreciation of the dollar makes
U.S. goods cheaper to foreign
buyers.

18. ADDING THE PUBLIC SECTOR[“ ”] $20 bil. on National Defense
C + Ig + Xn + G
Increases in public spending, like increases in private consumption, shifts the AE schedule upward resulting in greater equilibrium real GDP.
C + Ig + Xn
Consumption
Aggregate Expenditures (billions of dollars) 45 o o
550
Real GDP (billions of dollars)

19. $20 bil. on National Defense
MPC = .75
Multiplier = 4
$20 bil. on National Defense
Government
Spending of
$20 Billion
C + Ig + Xn + G
And just like private consumption government spending is subject to the multiplier effect.
C + Ig + Xn
Consumption
Aggregate Expenditures (billions of dollars) 45 o o
550
Real GDP (billions of dollars)

20. If government raise taxes (T), the result will be a decrease in GDP
If government raise taxes (T), the result will be a decrease in GDP. But not by the same multiple as the multiplier effect.
Aggregate Expenditures (billions of dollars) 45 o o
Real GDP (billions of dollars)

21. Taxes (T) reduce DI (consumption and savings)
Taxes (T) reduce DI (consumption and savings). So equilibrium real GDP will be reduced by MPC/MPS.
Aggregate Expenditures (billions of dollars) 45 o o
Real GDP (billions of dollars)

22. MPC MPC/MPS = MT .90 MPC/.10 = 9 .80 MPC/.20 = 4 .75 MPC/.25 = 3
This is called the tax multiplier effect (MT)
MPC MPC/MPS = MT
.90 MPC/.10 = 9
.80 MPC/.20 = 4
.75 MPC/.25 = 3
.60 MPC/.40 = 1.5
.50 MPC/.50 = 1
Taxes affect AE through consumption spending and savings; government purchases affect AE only through consumption.

23. S Real GDP = 550 billion Taxes increase by $20 billion MPC = .75
What will be the affect on GDP? S
C + Ig + Xn + G
Ca + Ig + Xn + G
Aggregate Expenditures
-20 x 3 = -$60 45 o o
490
550
Real GDP (billions of dollars)

24. Change in spending ($10B)
The Tax Multiplier (MT) Effect
MPC(.75) =
MT(3)
MPS(.25) x =
MT(3)
Change in GDP($30B)
Change in spending ($10B)
MPC and the MT MT
MPC .9 .8
.75
.60 .5 9 4 3
1.5 1

25. Balanced Budget Multiplier [$20 billion]
GDP =
$80
Net Change in GDP =
+$20
The increase in “G” flows directly into the economy.
The increase in “T” means we will consumed $15 less and save $5 less.
GDP =
-$60
T $20
Sa= -$5
G $20
Ca= -$15
ME = 1/MPS
ME = 1/.25 = 4
So, 4 x $20 = $80
MT = MPC/MPS=.75/.25=3
So, 3 x -$20 = -$60
MPC = .75

26. Balanced-budget multiplier – an equal change in government spending and taxes will change AE by the same amount AS
President Clinton used this strategy to help the economy grow in the 1990s.
AD1
AD2

27. When the economy falters, Presidents Use Their Facial Leadership to Coerce Congress To Help The Economy So They Can Win Re-election.

28. Changes in Equilibrium: Recessionary Gap [MPC = .75]
Recessionary gap- the amount by which actual GDP fall short of full-employment GDP (FE).
Because MPC =.75, a $5 billion spending gap will create a $20 billion decrease in GDP.
AE1
530
510
490
AE2
Aggregate Expenditures (billions of dollars)
Recessionary
Spending Gap= $5 Billion
Full Employment
[Recessionary GDP gap is $20B] 45 o o
490
510
Real GDP (billions of dollars)

29. Government can plug the recessionary gap by increasing “G”.
AE2
530
510
490
AE1
Aggregate Expenditures (billions of dollars)
Recessionary Spending
Gap = $5 Billion
Need
Job
Full Employment
[Recessionary GDP gap is $20B] 45 o o
490
Real GDP (billions of dollars)

30. Inflationary Gap – the amount by which actual GDP exceeds FE GDP.
MPC=.75
AE2
Inflationary Spending Gap
= $5 Billion
AE1
530
510
490
It takes $2 to buy what $1 used to buy.”
Aggregate Expenditures (billions of dollars)
Full Employment
[Inflationary GDP gap of $20B] 45 o o
Real GDP (billions of dollars)

31. Demand-pull inflation is a result of the inflationary gap
Demand-pull inflation is a result of the inflationary gap. Government can plug the inflationary gap by
cutting “G”, or by increasing taxes. S
Inflationary
Spending Gap= $5 Billion
AE1
AE2
530
510
490
We have “too many dollars chasing too few goods.” I’m going to burn some.
Aggregate Expenditures (billions of dollars)
[-$5 bil. X 4 = -$20 bil.]
$20 B Inflationary GDP Gap] 45 o o
Real GDP
Full Employment

32. At Equilibrium, All Injections = All Leakages
Injections = Leakages
C+Ig Ig(20) = S(20)
[Private-closed]
C+Ig+Xn X(10) = M(10)
[open]
C+Ig+G+Xn G(20) = T(20)
[open with G]

33. The End