Chapter 28: Aggregate Expenditures:
The Multiplier, Net Exports, and Government
1. The multiplier effect is that a change in a component of aggregate expenditures leads to a larger
change in equilibrium GDP.
Multiplier =
Change in real GDP
Initial change in spending (C or I or G or Xn)
Thus, the change in real GDP = multiplier x initial change in spending.
The expenditure multiplier =
_ 1_
MPS
__1___
or
1 – MPC
2. Net exports (Xn) = exports (X) – imports (M). Positive net exports (X >
M) will increase aggregate expenditures whereas negative net exports (X
< M) will decrease aggregate expenditures.
3. Increases in public or government spending (G) will increase aggregate
expenditures whereas decreases in G will decrease aggregate expenditures.
4. Changes in taxes will have a smaller multiplied effect on equilibrium than
the expenditure multiplier above because taxes initially change disposable
income before affecting consumption. For example, if the government
reduces taxes by a lump sum of $20 billion at all levels of disposable income and the MOC is
0.75, people will only spend $15 billion and save $5 billion. Thus, the multiplied effect would
increase GDP by $60 billion ($15 billion x 4). Thus the tax multiplier is only 3. Contrast this to an
increase in government spending by $20 billion which would increase GDP by $80 billion ($20
billion x 4).
The tax multiplier =
- MPC
1 – MPC
5. Equal increases in government spending and taxation increase the equilibrium GDP by the
amount of the increase. If the government increased both taxes and spending money by $40
billion, equilibrium GDP would increase by $40 billion. If the MPC were 8, the government
spending would increase equilibrium GDP by $200 billion ($40 billion x 8) whereas the increased
lump sum tax of $40 billion would first lower disposable income by $32 billion ($40 billion x 0.8)
and then reduce equilibrium GDP by $160 billion ($32 billion x 5). $200 billion - $160 = $40
billion. Government spending affects aggregate expenditures more powerfully than a tax change
of the same size.
The balanced budget multiplier = 1
6. A recessionary gap is the amount by which aggregate expenditures at the full-employment level
GDP fall short of those required to achieve the full-employment GDP. If full employment GDP
were $500 billion, and actual equilibrium GDP $400 billion and the MPC 0.8, aggregate
expenditures would have to increase $20 billion ($100 billion/5) to solve the recessionary gap.
7. An inflationary gap is the amount by which an economy’s aggregate expenditures at the fullemployment GDP exceed those necessary to achieve the full-employment GDP. If full
employment GDP were $500 and actual equilibrium GDP $750 billion and the MPC 0.9,
aggregate expenditures would have to be reduced by $25 billion ($250/10) to solve the
inflationary gap.