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
0
