ECONOMICS GRADE 12 TOPIC: ECONOMICS – Circular Flow : the Multiplier PRESENTER: Gabriel Leteane WhatsApp Respondent : Leah Mofokeng DATE: 19 January 2022 INTRODUCTION • We will be dealing with the Topic of the Multiplier (Grd 12) Content Progression GRADE 10 Participants, markets (product and factor markets), and monetary and real flows in an open economy. • The circular flow diagram: • The participants: • Markets - product and factor markets • The flows of the variables • Leakages and injections • Derive GDP and GNI, define them and illuminate their importance: - definitions - composition - importance - comparison GRADE 11 National Aggregates GRADE 12 The circular flow model as a macroeconomic model: deducing and analysing the national account aggregates; derive and apply the multiplier. • The open economy circular flow model • The markets • National account aggregates and conversions • The multiplier -explanation of the multiplier process aided with a circular flow and examples THE MULTIPLIER • This concept was developed by the British economist J.M. Keynes. • His theory was that any increase in injections into the economy (investments, government expenditure or exports) would result in a proportionally larger increase in the national income • The economy is in equilibrium if LEAKAGES (WITHDRAWALS) = INJECTIONS • L = J or S + T + M = I + G + X • The multiplier is based on the principle that spending by one person becomes the income of another person, which then becomes that person’s spending, which turns into the income of yet another person (re-spending effect). THE MULTIPLIER Example • The Government decides to increase its spending by building new roads • This creates jobs and raises the level of employment. These newly employed people then use their income to purchase consumer goods • This stimulates the demand for goods and services and results in an increase in production, which will in turn increase the level of employment even further • This raises income and stimulates greater consumer demand and so on and so on. THE MULTIPLIER Example (conti …) • This implies that a multiplier process occurs in the economy when injections into the circular flow of spending, production and income take place • The multiplier refers to the ratio used to work out the difference between the initial investment and the eventual change in income • The size of the multiplier differs according to the extra income produced or created in each round of spending, but this depends on the marginal propensity to consume (mpc), that is, how many of every rand income earners are willing to spend. THE MULTIPLIER Concepts: • Consumption is the use of goods and services • Consumption expenditure (C) is the purchase of goods and services for the use by households • Autonomous consumption is that part of spending/expenditure which is independent of the level of income • Induced consumption is the portion of consumption that varies with disposable income. • Investment (I) is spending by firms on capital goods THE MULTIPLIER Concepts (Conti…) • The multiplier describes the fact that changes in spending have an impact on income that is greater than the original change in spending • Multiplier effect refers to a small initial change in spending which produces a proportionately larger increase in national income. • Marginal propensity to consume (mpc) is the proportion of any small increase in income that is spent on consumer goods and services THE MULTIPLIER Concepts (Conti…) • Marginal propensity to save (mps) is the proportion of any small increase in saving that is a result of an increase income. • Marginal propensity of taxation (mrt) is the proportion of any small increase in taxation that is the result of an increase in income • Marginal propensity to import (mrm) is the proportion of any small increase in imports that is the results of an increase in income. THE MULTIPLIER The multiplier in a two-sector model • The participants are the households (consumers) and firms (businesses) • The model assumes that there is no government intervention, and no foreign trade exists. • There is one leakage and one injection • The leakage is savings (S) by households and the injection is investment (I) • Consumers either spend their money or save it. THE MULTIPLIER The multiplier in a two-sector model (Conti…) • The proportion spent shows the marginal propensity to consume (mpc) • The proportion saved shows the marginal propensity to save (mps). • The size of the multiplier depends on the proportion of any increase in income that is spent THE MULTIPLIER Formula in a 2-sector economy • Multiplier = 1 (1−πππ) or • or ΔY Δπ¬ 1 mps THE MULTIPLIER The multiplier in a two-sector model (Conti…) • The larger the mpc the bigger the multiplier and the smaller the mpc the smaller the multiplier • It is the money that stays in the economy. For example: • Y = R100 000 • S = 40 000 = 40% • E = 60 000 = 60% • Marginal propensity to consume (mpc) = 0.6 • Marginal propensity to save (mps) = 0.4 • The total of mpc + mps is always = 1 THE MULTIPLIER • Example of using formula • Calculate the value of the multiplier if the households consumes(spent) 50% of their disposable income. Multiplier = Multiplier = Multiplier = 1 (1−πππ) 1 (1−π,π) 1 (π,π) Multiplier =2 • The larger the mpc the bigger the multiplier and the smaller the mpc the smaller the multiplier THE MULTIPLIER • Example cont… • Calculate the value of the multiplier if the marginal propensity to save of 0.4. Multiplier = Multiplier = 1 πππ 1 π,π Multiplier = 2,5 THE MULTIPLIER THE MULTIPLIER In the above graph: • E = Original equilibrium. • Y = Original income. • AE = C + I (Original aggregate expenditure) • The 45° line shows the point where income and expenditure are equal. It is also known as the Keynesian line • Aggregate expenditure (AE = C + I) shows the initial equilibrium of Y at point E. • New investment is made and raises AE curve upwards to AE1. • The AE1 curve intersects with the 45° line at point E1 and therefore Y shifts to Y1. THE MULTIPLIER • The new equilibrium position is at E1 where aggregate expenditure is equals aggregate income. • Planned spending determines aggregate expenditure. Aggregate demand increases to AD1. • The increase in investment (I) led to an amplified change in equilibrium income. • The amplified change is the multiplier effect. THE MULTIPLIER • Equilibrium income increases by more than the increase in initial expenditure. • The multiplier effect occurs when a small increase in spending leads to a proportionally larger increase in national income THE MULTIPLIER • Application of the Multiplier graph with figures MULTIPLIER AGGREGATE EXPENDITURE (BILLIONS) Y=E AE1=500+0.5Y AE=200+0.5Y 500 200 0 400 1000 AGGREGATE OUTPUT, Y (BILLIONS) THE MULTIPLIER In the graph • It is also known as the Keynesian line • The original consumption function is presented by AE=200+0,5y Y=E AGGREGATE EXPENDITURE (BILLIONS) • The dotted or 45° line shows the point where income and expenditure are equal. MULTIPLIER • The mpc is denoted by the value in front of Y in the graph above which is 0,5 AE1=500+0.5Y AE=200+0.5Y 500 200 0 400 1000 AGGREGATE OUTPUT, Y (BILLIONS) THE MULTIPLIER Cont. MULTIPLIER • Suppose there is an increase in investment of R300b the AE will increase to R500b • There will be a new consumption function which is presented by AE1=500+0,5Y • There will be a new equilibrium income when income increase from R400 to R1000 AGGREGATE EXPENDITURE (BILLIONS) Y=E AE1=500+0.5Y AE=200+0.5Y 500 200 0 400 1000 AGGREGATE OUTPUT, Y (BILLIONS) THE MULTIPLIER MULTIPLIER • And the multiplier will be calculated as follows 1 α or k= π−πππ 1 = π−π,π 1 = π,π =2 AGGREGATE EXPENDITURE (BILLIONS) Y=E AE1=500+0.5Y AE=200+0.5Y 500 200 0 400 1000 AGGREGATE OUTPUT, Y (BILLIONS) THE MULTIPLIER • Calculating the value of the multiplier using MULTIPLIER = = πππ πππ = 2 Y=E AGGREGATE EXPENDITURE (BILLIONS) α ΔY or k= Δπ¬ (ππππ−πππ) (πππ−πππ) AE1=500+0.5Y AE=200+0.5Y 500 200 0 400 1000 AGGREGATE OUTPUT, Y (BILLIONS) THE MULTIPLIER MULTIPLIER Y=E AGGREGATE EXPENDITURE (BILLIONS) • Cont.….. • The increase in investment (I) led to an amplified change in equilibrium income. • The amplified change is the multiplier effect. • The multiplier effect will be 2 x R300 = R600b AE1=500+0.5Y AE=200+0.5Y 500 200 0 400 1000 AGGREGATE OUTPUT, Y (BILLIONS) THE MULTIPLIER The multiplier in a three-sector model: • When a government sector is added to the circular flow model, more leakages and injections occur. • The injections are investment spending and government spending. The leakages are as follows: a) mps = marginal propensity to save b) mrt = marginal rate of taxation The formula to calculate the multiplier in a three-sector model: α = 1/1 − πππ = 1/πππ +πππ‘ THE MULTIPLIER The multiplier in a four-sector model: • When the foreign sector is added to the circular flow model, more leakages and injections occur. • The injections are investment spending, government spending and exports. The leakages are as follows: a) mps = marginal propensity to save b) mrt = marginal rate of taxation c) mpm = marginal propensity to import THE MULTIPLIER • The formula to calculate the multiplier in a four-sector model: α = 1/1 −πππ = 1/πππ +πππ‘+mpm • Savings, taxes and imports make the multiplier smaller than it would otherwise be. • The larger the mps, the mpt and the mpm, the smaller the multiplier. If leakages are higher, the multiplier will be smaller and visa versa. 29 EXAMPLE OF MULTIPLIER QUESTION Study the graph and answer the questions that follow: AE=20+0.6Y EXAMPLE OF MULTIPLIER QUESTION Provide a name for the line labelled AE=Y Keynesian line/ 45° line β Which Economic participant can invest in a two sector model? Businesses/private sector/ Producers/firmsβ EXAMPLE OF MULTIPLIER QUESTION Briefly describe the term induced consumption. Induced consumption is the portion of consumption that varies with disposable income/When a change in disposable income “induces” a change in consumption on goods and services, then that changed consumption is called “induced consumption” β β What is a disadvantage of a low marginal propensity to consume? • Low economic growth due to small size of the multiplierβ β • Low equilibrium national incomeβ β EXAMPLE OF MULTIPLIER QUESTION Calculate the equilibrium income (Ye) using the information from the graph 1/ 1-mpc x  = 1 /1 – 0.6 x 20 β = 1/0.4 x 20 = 2.5 x 20 β = 50 β β Section B – Paragraphs (MO) – Example Discuss the multiplier effect on the national income.(8) • The multiplier relates to how much the national income changes as a result of an injection or withdrawal οο • An increase in injections into the economy (investment, government spending or exports), which would lead to a proportionate increase in national income οο Section B – Paragraphs – Example …continued • Extra spending would have a knock-on effect and create even more spending οο • The size of the multiplier also depend on the level of leakages οο • The size of the multiplier is directly proportional to the level of national income created οο (4 x 2) (8) EXAMPLE OF MULTIPLIER QUESTION Government injects R20 million in the economy as an investment to improve infrastructure. Calculate the multiplier effect of this investment on the economy if the marginal propensity to save (mps) is 0,2. Show ALL calculations. (8) THE MULTIPLIER (MO) QUESTION- EXAMPLE With the aid of a correctly labelled graph, explain the multiplier (Nov 2021) (8) E=Yο E1 E1=C+I Expenditure E=C+I AE1 ο E AE 45O Y 1ο Y INCOME β • Labelling of axis = 1 Mark • Labelling on axis = 1 Mark • Shift of consumption function = 1 Mark • E = Y : 1 Mark THE MULTIPLIER QUESTION - EXAMPLE With the aid of a correctly labelled graph, explain the multiplier (8) • The multiplier effect occurs when a small increase in spending leads to a proportionally larger increase in national income οο • At the income of Y the expenditure curve intersects the vertical axis at AE οο • An increase from AE to AE1 means more money is injected in the economy οο • This causes a proportinaly larger increase in income from Y to Y1 οο EXAMPLE OF MULTIPLIER QUESTION Study the graph below and answer the questions that follow. EXAMPLE OF MULTIPLIER QUESTION • Identify the original consumption function on the graph. (1) E0 = 20 + 0.5Y ο • What is the new consumption function on the graph? (1) E1 = 30 + 0.5Y ο • Briefly describe the term induced consumption. (2) Induced consumption is the portion of consumption that varies with disposable income/ It takes place when a change in disposable income ‘induces’ a change in consumption on goods and services. οο EXAMPLE OF MULTIPLIER QUESTION • How do investors impact on the multiplier? (2) The larger the investors’ spending, the larger the multiplier, and vice versa. οο ΔY Δπ¬ • Use the formula to calculate the multiplier for the above scenario. (4) (k) = Δπ/Δπ½ = 20/10 οο = 2 οο EXAMPLE OF MULTIPLIER QUESTION • MULTIPLIER Assume an economy is initially in equilibrium where income (Y) equals R100 000m, savings (S) R40 000m and consumption (C) R60 000m. [Source: Enjoy Economics, 2012] Briefly describe the term macroeconomic multiplier. • A small increase in spending produces a proportionately larger increase in national income ββ (2) What does the term equilibrium in this extract refer to? • Injections = Leakages ββ (2) EXAMPLE OF MULTIPLIER QUESTION Calculate the marginal propensity to consume (mpc). • mpc = R100 000 – R40 000 = R60 000 • 60 000 β= 0,6 β or 0,6 ββ (2) Calculate the value of the multiplier. Show ALL calculations. • K= • • 1 1−πππ 1 = οο 1−0.6 = 2,5 ββ (4) THE MULTIPLIER QUESTION - EXAMPLE Study the extract below and answer the questions that follow. THE MULTIPLIER PROCESS The country X has a closed economy without government. The citizens save 25% of all income earned. The national income increased to R200 million from to R160 million in 2021. the initial autonomous expenditure was R40 million. Identify the original equilibrium income in the extract above. (1) • R160mο EXAMPLE OF MULTIPLIER QUESTION What percentage of income earned is consumed by the country’s citizens in the extract above? (1) • 75%ο Briefly describe the multiplier process. (2) • The process whereby a small change in injections results in proportionally larger increases in the national income.οο EXAMPLE OF MULTIPLIER QUESTION How does marginal propensity to consume (mpc) relate to the size of the national income. (2) • Higher mpc leads to higher national income/ Lower mpc leads to lower national income.οο Calculate the amount of investment made leading to the new national income of R200 million. Show calculations (4) k= π π−πππ π π−π,ππ π = ο π,ππ = = 4β EXAMPLE OF MULTIPLIER QUESTION = ΔY/π€ = πππ−πππ π β = R10m β
