module 16d-the magic of the multiplier j.a.sacco
TRANSCRIPT
Module 16D-The Magic of the Multiplier
J.A.Sacco
The MultiplierThe Multiplier Multiplier
The ratio of the change in the equilibrium level of real national income to the change in any autonomous expenditures.
It is the number by which a permanent change in autonomous expenditures is multiplied to get the change in the equilibrium level of real national income.
Think of the multiplier as an amplifier of autonomous expenditures leading to a change in real national income.
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The MultiplierThe Multiplier
3
C
Real National Income per Year($ trillions)
Pla
nn
ed C
on
sum
pti
on
an
d In
vest
men
t p
er Y
ear
($ t
rilli
on
s)
0 1.0 2.0 3.0 4.0 6.0
1.0
3.0
5.0
0.345o
C + I = Y
4.0
2.0
6.0
5.0
C + I
-Without I -- equilibrium = $1.5-With I -- equilibrium = $5 -The change in Y (3.5) was 5 times the change in I (.7)
1.5 WHY?
The MultiplierThe Multiplier
Question How can $.7 trillion of I generate $3.5
trillion of Y Answer
The autonomous spending multiplier
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Note- Any permanent decrease in autonomous spending will cause a larger decrease in the equilibrium level of real national income. Here the multiplier works in reverse.
The Multiplier ProcessThe Multiplier Process
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Assumption: MPC = .8 or 4/5
Annual Increase Annual Increase Annual Increasein Real in Planned in Planned
National Income Consumption SavingRound ($ billions per year) ($ billions per year) ($ billions per year)
1 ($100 billion per year increase in I 100.00 80.000 20.000
2 80.00 64.00 16.000
3 64.00 51.200 12.800
4 51.20 40.960 10.240
5 40.96 32.768 8.192
. . . .
. . . .
. . . .
All later rounds 163.84 131.072 32.768
Totals 500.00 400.00 100.000
Multiplier is “5”
The MultiplierThe Multiplier
The Multiplier Formula
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MPS-MPC
1
1
1 Multiplier
Sacco Tip- The multiplier is the reciprocal of the MPS.
The MultiplierThe Multiplier Example- If MPC is 4/5, then MPS is
___. What is the multiplier?
Example- If the MPC is .50, then the MPS is___. What is the multiplier?
The MultiplierThe Multiplier Examples
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5
4MPC
5
1MPS 5
51
1. Mult
4
3MPC
4
1MPS 4
41
1. Mult
3
2MPC 3
1MPS 3
31
1. Mult
5
3MPC 5
2MPS 5.2
25
1. Mult
9
7MPC
9
2MPS 5.4
29
1. Mult
The MultiplierThe Multiplier Question
How does the size of the MPC influence the value of the multiplier?
Answer The smaller the MPS, the larger the
multiplier. The larger the MPC, the larger the
multiplier.
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The MultiplierThe Multiplier Question- What would happen to
the multiplier if people saved more of their additional income? Less of their income?
Answer- Multiplier smaller/larger.
The MultiplierThe Multiplier Measuring the Change in
Equilibrium Income from a Change in Autonomous Spending
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Multiplier x Change in autonomous spending =
Change in Equilibrium Income (Output)
The MultiplierThe Multiplier Q1- MPC=0.8. Change in autonomous
spending is $100B. What is the change in real national income? Q2- If the multiplier is 4, how much
additional gov’t spending would be necessary to increase the economy by $1B?
Q3- If the multiplier is 4, how much would the gov’t have to cut spending to lower demand by $4B?
The MultiplierThe Multiplier Answer 1- $500B Answer 2- $250M Answer 3- $1B
The MultiplierThe Multiplier Question
What does the multiplier tell us about the potential impact on the economy from a change in autonomous spending?
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When is the multiplier most important?
Changes in InvestmentChanges in Investmentand the Great Depressionand the Great Depression
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What does the Investment Schedule and Business Cycle suggest?
Tax Multiplier Up to this point have looked at the
spending/expenditure multiplier on autonomous expenditures.
What about a decrease or increase in taxes? It’s important to know that the typical household
will treat a decrease in taxes as in increase in disposable income. Most will increase consumption by a factor of the MPC and save based on the MPS. It is important to know that less than 100% of this increase in disposable income will circulate throughout the economy because most households will save a portion of it
Tax Multiplier Example of the tax multiplier 1) MPC is .90, tax refund=$200. 2) Tax multiplier process begins but not on the
entire $200, only on the consumed portion of $180 because $20 is saved
3) Therefore with an MPC of .90 the autonomous spending multiplier is 10, but the tax multiplier Tm, which is 9, is smaller.
4) Tax multiplier is smaller by 1. The savings acts as a leakage.
Tax Multiplier So for our example: Tm=MPC x (Spending multiplier)=.90x(1/.10)= 9
*the tax multiplier is always smaller than the spending multiplier by 1. Always!!!Try This!- MPC is .80 and the government decides to
impose a $50 decrease in taxes. How does this effect real national income? Explain your reasoning.
Answer- Since the tax multiplier is 4, real national income would increase by $200 not by $250 as with the autonomous spending multiplier/
Note- Tax multiplier is negative with an increase in taxes!
Spending Multiplier vs.Tax Multiplier
Scenario- The nation is in a recession. What would be more effective to help end the recession, a $500 B tax refund to the entire population or a $500B autonomous government expenditure? Explain your answer.
The Multiplier Effect WhenThe Multiplier Effect Whenthe Price Level Can Changethe Price Level Can Change
The multiplier effect on equilibrium real national income will not be as great if part of the increase in nominal national income occurs because of increases in the price level.
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Multiplier Effect onMultiplier Effect onEquilibrium of Real National IncomeEquilibrium of Real National Income
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AD2
With $100 billionincrease in autonomousspending
SRASSRASLRAS
AD1
Real National Income per Year($ trillions)
Pri
ce L
evel
0 5.0
120
Multiplier Effect onMultiplier Effect onEquilibrium of Real National IncomeEquilibrium of Real National Income
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SRAS
AD2
SRASSRASLRAS
AD1
Real National Income per Year($ trillions)
Pri
ce L
evel
0 5.0
120
5.5
With constant prices,real national incomeincreases to 5.5 trill.
125
5.3
With price adjustment,the multiplier effect is less.
What is the point being made here?