Equilibrium GDP and the
Multiplier Effect
Aggregate Expenditures
• The total amount spent on final goods and
services.
• AE consists of (C) consumption + (Ig) Gross
Investment. AE = C + Ig
Equilibrium GDP
• The level at which the total quantity of goods
produced equals the total quantity purchased.
• There is no surplus or shortage of goods.
• This means no unplanned changes in
inventory.
• Below equilibrium GDP, there would be
upward pressure on employment, output, and
income. Above equilibrium, the opposite.
Graphical Analysis
Savings Equals Planned Investment
• Savings (S) and Planned/Gross Investment (Ig)
are equal at equilibrium GDP.
• Savings is a leakage, or a withdrawl of
spending. but, it can also be thought of as an
injection.
• As an injection, savings essentially results in
Gross Investment, which increases Income
GDP.
The Multiplier Effect
• The multiplier effect shows that an initial
change in spending can cause a larger change
in DI and output or GDP.
• The multiplier determines how much larger
that change will be.
• It measures the effect that any change in
expenditure (G, C, Ig, or Xn) will have on GDP.
The Multiplier Effect
• Multiplier = Delta GDP / Delta Spending
Or… Change in GDP = Multiplier x Delta Spending
• When Person A spends his money, it becomes
person B's income. Then person B will go spend
their income, which then becomes person C's
money, etc.
• The cycle repeats, but because of the tendency to
save, the amount spent in each cycle is less and
less.
The Multiplier and
Marginal Propensities
• The higher the MPC (thus, lower MPS), the
larger the multiplier because the multiplier is
equal to (1 / MPS)
• If the multiplier is equal to the reciprocal of
the marginal propensity to save, the greater
the marginal propensity to save, the smaller
the multiplier, and vice versa.
• High MPC = High Multiplier.
Significance of the Multiplier
• Small changes in consumption and savings can
trigger large changed in GDP.
• For countries that have a high MPC, this can
create large boom and bust business cycles.
• There is also a complex multiplier that
includes other leakages besides savings. These
include taxes and imports.
Test Preparation
• Complete Questions 9, 10, and 17 on pages
223 and 224.