Chapter 26: Changes in Income and the Multiplier
The Income Effects of Changes in Investment
-
A given change in investment will lead to an even greater change in income.
-
The equilibrium level of income occurs at the intersection of the investment line and savings live, also the intersection of the 45 degree-line and the Aggregate Expenditure.
-
An increase in investment spending increases equilibrium income.
The Income Effects of Changes in Saving
-
Other things being equal, an increase in saving results in a reduction in total income.
The Paradox of Thrift (Paradox of Saving)
-
The Paradox of Thrift (Saving) states that an increase in intended aggregate, other things being equal, will lead to a fall in total income, and hence to a a fall in actual aggregate saving.
-
An increase in saving reduces equilibrium income.
-
An increase in total injections will tend to increase income. An increase in total withdrawals will tend to reduce total income.
-
An upward shift of the saving curve reduces the level of actual saving.
The Multiplier
-
The Multiplier tells the amount by which a change in spending will change income.
-
Multiplier = Change in Y = Y1 – Y
Change in X I1 - I
Y = Income I = Aggregate Investment
-
The change in income is greater than the change in investment that caused it.
Relation Between the Multiplier, the MPC, and the MPS
-
The Multiplier is the reciprocal of MPS. The Multiplier = 1
MPS

-
Since MPC + MPS = 1, it follows that MPS = 1 – MPC
Hence the formula for the: Multiplier = 1
1 - MPC
- The steeper the saving curve (the higher the MPS), the less the multiplier effect will be.
- The flatter the saving curve, the greater the multiplier effect
A More Realistic Multiplier
- The Marginal Propensity to Withdraw is the fraction of extra income allocated to savings, taxes, and imports. MPW = Change in W
Change in Y
- The Generalized Multiplier is the reciprocal of the marginal propensity to withdraw.
Generalized Multiplier = 1
MPW
The Full Employment Gaps
The Inflationary Gap
-
An Inflationary Gap results when total spending exceeds the fullemployment level of output.
-
The Inflationary gap equals desired aggregate expenditure minus the full employment output.
-
The gap between the full-employment level of output and the equilibrium level of output is the income or output gap.
The Deflationary Gap
-
A Deflationary Gap (Recessionary Gap) exists when total spending is less than the full-employment output.
The Need for Policy
-
Policies may be required to shift AE in order to close the gaps.