Multiplier and Accelerator
Reference: Glanville, pgs. 265-270
Multiplier – increases and decreases in AD (that is C + I + G + (X – M))
has a bigger effect on RGDP than the actual size of the change.
Initial Change – amount of the autonomous expenditure PLUS the
amount of the expenditure which is income dependent
 autonomous expenditure: actual change in consumption,
investment, government or net export spending -- the
independent change
 income dependent change: how much new income results
from the subsequent spending
o each round of spending will have to take into account
the leakages – savings, taxes, import spending
o this will continue and continue
Important things to know in calculating and using the multiplier –
Marginal Propensity to Consume (MPC) – increase in consumption
arising from the increase in income
 MPC = change in consumption / change in income
 MPCd: marginal propensity to consume DOMESTICALLY
produced goods and services
Multiplier = 1/1 minus MPCd
Or
Multiplier = 1/ 1 – MPC
Multiplier = 1/ MPS + MRT + MPM
 where MPS = marginal propensity to save = ∆ savings/∆
income
 MRT = marginal rate of tax
 MPM = marginal propensity to import = ∆ imports/∆ income
o Marginal Propensity to Withdraw = MPS + MRT + MPM
Calculating the impact of a change in AD (an autonomous expenditure)
 Change in GDP = (1/1-MPCd) (change in the autonomous
expenditure)
 The multiplier will always be >1 as its impact will be greater
than the change in autonomous expenditure
 the higher the MPCd the higher the mulitiplier
 When the autonomous expenditure is POSITIVE it will cause
RGDP growth
 When the autonomous expenditure is NEGATIVE it will cause
a decline in RGDP
Accelerator – this focuses on Investment within AD
 two kinds of investment
o replacement investment for depreciated capital
o new investment for increased AD – induced
investment
 this is only necessary when capital is fully
employed
 if capital is idle, it will be re-employed, if strong
AD continues, companies will then consider
capital expansion
 As AD increases, a company will have to replace depreciated
capital and assess whether to expand capital capacity
o Replacing depreciated capital tends to be a small-ish
amount
o Expanding capital tends to be a big-ish amount –
expanding to meet a change in demand may require
large investments in capital equipment to meet the new
demand
 A whole new production line
 A new machine
So,
 the level of induced investment is determined by the rate of
change in National Income (GDP)
o when it’s rising, firms want to meet it so they INVEST to
expand capacity
o this investment is subject to the multiplier effect in the
economy and will accelerate growth in NI
o when NI is stagnant or negative, investment will slow
or stop
o investment is strongly linked to CONFIDENCE in the
marketplace
Crowding Out – Government’s influence in the economy
If govts run big deficits, they must borrow money to finance the
borrowing – there is a limited amount of loanable funds, govts must
compete with private sector borrowing for the funds
Ex: US government runs a current account deficit (import values
exceed export values) + a budget deficit (spends more than it receives
in tax revenue) + initiating big stimulus programs (bank rescue, fiscal
stimulus)
These demands on the credit market may force private sector
borrowing out
Int rate
int rate
S
I2
i1
D2
I
D1
Qty of loanable funds
I2 I1
Inv