Thursday, February 4th, 2009.

The Multiplier

Autonomous Expenditure Ù Independent of charges in Y [GDP]

Induced Expenditure Ù Varies as Y [GDP] varies

Change in Autonomous Expenditure => shift in AE Schedule => new intercept of AE

Schedule

The Multiplier Concept

1. ¨< PXOWLSOLHU¨ Autonomous Expenditure

Example: ¨ $XWRQRPRXV([SHQGLWXUH ¨,

2. Induced consumption expenditure is key

Round #1 ¨I = 10 !¨<

Round #2 ¨& PSF¨< !¨Y = 9

Round #3 ¨& PSF¨< !¨< 8.1

** mpc = marginal propensity to consume

Round #1 ¨ Autonomous Expenditure

Round #2 Induced Consumption Expenditure

Round #3 Induced Consumption Expenditure

** expenditure = income

=/[A[

450

C + I = AE

Y National Output

Aggregate

Planned

Expenditure

45°

¨I = 10

350

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The Multiplier: Value

1. Slope of AE schedule

AE = C + I = 10 + 0.9Y + 25 = 35 + 0.9Y

Slope = 0.9

2. Multiplier = 1 .

1 ± slope of AE schedule

= 1 .

1 ± 0.9

= 10

Observation: In this model, slope of AE Schedule is mpc, so multiplier is 1___

1 ± mpc

Extended Model

AE = C + I + G + X ± M

Government Sector

G = Government expenditure

T = Taxes

(Note: T affects AE indirectly by influencing C)

Foreign Sector

X = Exports

M = Imports

Government Spending and Taxes

1. Spending __

G = G political determinants

2. Taxes

2.1 T = t * Y where t = marginal tax rate

T = 0.2 Y numerical example

2.2 YD (Disposable Income) = Y ± T

C = C0 (constant) + C1 (mpc) YD

= C0 + C1 (Y ± T)

Consumption and Real GDP (National Income)

C = 10 + 0.9 YD Note: YD

T = 0.2 Y

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