Threshold Network Exercise: the changing value of the multiplier
1
Scenario
Over the past 30 years, and particularly since our entry into the EU, imports
(and exports) as a proportion of GDP have risen considerably in the UK.
What effect has this had on the value of the multiplier in the UK? What
implication does this have for the effect of an increase in government
expenditure on the economy?
In doing this you should:
(1) Consider an economic framework or model that you think is going to
be useful.
(2) Identify three important economic concepts from the list below you
would use in answering this question and explain why they are
important in this context.
Inflation
Exports
Investment
Marginal propensity
Withdrawals
Injections
Social costs
Imports
Consumption
Oligopoly
(In the list there are concepts that are irrelevant and concepts that are useful. Some are
arguably more useful than others. Although there are some ‘wrong’ answers there is not just
one ‘correct’ one. Our feedback highlights our choice of three concepts but you will find we
use others on this list as well. In making your choice try to discard the irrelevant and consider
what you think is the most important amongst the others and why.)
feedback page 2
Copyright: Embedding Threshold Concepts Project
05/09/08
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for
Employment and Learning (DEL) under the Fund for the Development of Teaching and Learning.
Threshold Network Exercise: the changing value of the multiplier
2
Feedback
Let us start by considering what determines the multiplier:
An increase in autonomous expenditure, such as investment government
expenditure or exports increases incomes (as more people are employed, for
instance, on building projects). Some of this income is then spent on
domestically produced goods and so there is additional consumption. Firms
are selling more so they increase employment, which increases incomes, and
this leads to more increases in consumption and so on.
However, as people’s incomes increase they do not just consume more
domestically produced goods, they also save more, spend more on imports
and pay more in taxes (which are known as withdrawals and are assumed to
be endogenous). This means that the multiplier process does not continue
ad infinitum, but only until the new level of injections is matched by a similar
increase in withdrawals. This brings a new equilibrium. How much
withdrawals increase as income increases is crucially important – if there is a
large increase the multiplier process is reduced. This effect is given to us by
marginal propensity to withdraw (mpw): how much withdrawals increase with
an increase in income of £1.
The formula for the size of the multiplier is:
Multiplier = 1/ (mpw)
We can now directly relate this to the given scenario
Imports have risen as a percentage of GDP. This means that marginal
propensity to import has increased – for each extra £1 of income we spend a
greater proportion goes on imports. This is part of the marginal propensity to
withdraw, which therefore increases and the multiplier decreases (for instance
if the mpw goes up from 0.25 to 0.4 the multiplier reduces from 1/0.25 = 4 to
1/0.4 = 2.5).
What implication does this have for the effect of an increase in government
expenditure on the economy?
The multiplier tells us how much the government expenditure is magnified to
give the effect on income. We can show the effect with some simple figures.
If government expenditure increases by £100:
* if the multiplier is 4, the effect on income is 4 x 100 = £400
* if the multiplier is only 2.5, the effect on income is 2.5 x 100 = £250
Thus an increase in government expenditure will have a smaller effect on
income than 30 years ago.
Our choice of important concepts you could have identified are in bold. The
following concepts are not useful here: inflation, social costs and oligopoly.
‘Exports’ is not as useful a concept as ‘imports’ here- it is changes in the
marginal propensity to import that change the value of the multiplier. Exports
are assumed to be exogenous – in this model of the economy they do not
increase as domestic incomes increase.
Copyright: Embedding Threshold Concepts Project
05/09/08
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for
Employment and Learning (DEL) under the Fund for the Development of Teaching and Learning.
Threshold Network Exercise: the changing value of the multiplier
Reflection
1.
Do you understand why the concept of marginality
so important in answering this question?
2.
Are you clear why is the concept of equilibrium
important here?
2.
Do you understand why the increase in exports
mentioned in the scenario does not affect the value
of the multiplier in this model?
3
Yes
Partly No
If your answer is ‘No’ or ‘Partly’ to any of the above, which of the following do
you now intend to do to improve your understanding?
1. Ask for guidance from my tutor.
2. Read a relevant section in a textbook.
3. Work though some example questions.
Copyright: Embedding Threshold Concepts Project
05/09/08
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for
Employment and Learning (DEL) under the Fund for the Development of Teaching and Learning.
Threshold Network Exercise: the changing value of the multiplier
4
Notes for lecturers
Objectives of the exercise and prerequisites
The threshold network exercises are designed to help students recognise the
importance of economic concepts and modelling. They are concerned with
how economics uses a range of concepts (in a connected web) in answering
applied questions and getting students to recognise which concepts are
important and how they relate to each other in the specific context.
Learning Focus: Developing understanding of the multiplier and fiscal policy.
During the ‘Embedding Threshold Concepts’ project analysis of examination
answers and student group discussion revealed that students had difficulty in
understanding the role of equilibrium and this led to difficulties in
understanding the multiplier. In particular students did not recognise that
there was a limit to the process because they had not clearly identified the
endogenous processes that lead to equilibrium. The feedback and reflection
questions for this activity stress this aspect of understanding.
Threshold Concepts pivotal to this learning are the multiplier (cumulative
causation) and marginality.
Prior Knowledge Required:
Some prior knowledge of the multiplier; either the circular flow of income or
the income/expenditure model.
Timing
We would suggest that this exercise is likely to take students around 20
minutes to complete. It may be undertaken individually or in groups. This
timing does not allow for any presentation by students of their findings.
Copyright: Embedding Threshold Concepts Project
05/09/08
This project is funded by the Higher Education Funding Council for England (HEFCE) and the Department for
Employment and Learning (DEL) under the Fund for the Development of Teaching and Learning.