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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
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
Magic of the Multiplier
Packet
 Due today