 # Aggregate Expenditures: The multiplier Chapter 10 Part 2 of Unit 5.

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Aggregate Expenditures: The multiplier Chapter 10 Part 2 of Unit 5

Read Page 199  Squaring the Economic Circle

The Multiplier Effect  Small change in investment leads to a large change in output and income.  The multiplier determines how large the change will be  Multiplier = change in GDPr / initial change in spending  Ex. A \$5 billion change in Ig led to a \$20 billion change in GDP.  What is the multiplier? 4444

Rationale  The economy has continuous flows of expenditure & income—ripple effect  Income received by person A comes from \$ spent from person B.  Change in income will cause both C and S to vary in the same direction as the initial change in income (increase or decease) and by a fraction of that change.

Rationale continued  The fraction of the change in income that is spent is called the MPC  The fraction of the change in income that is saved is called the MPS

Multiplier & Marginal Propensities  The size of the MPC and the multiplier are directly related  The size of the MPS & the multiplier are inversely related  M = 1 / MPS  or  M = 1 / (1-MPC)

Significance of the Multiplier  A small change in investment plans or consumption savings plans can trigger a much larger change in the equilibrium level of GDP

Generalizing the Multiplier  We have seen the simple multiplier  The multiplier can be generalized to include other “leakages” from the spending flow besides savings  Realistic multiplier includes taxes and imports

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