The Multiplier Effect

HideShow resource information
The Multiplier Effect Define
Occurs when an initial injection into the economy causes a bigger final increase in national income
1 of 18
The multiplier effect equation
Multiplier (K) =Changes in real GDP (Y) /Changes in injectiosn (J)
2 of 18
The value of the multiplier depends on
1) MPC, if people spend a high % of extra incom, then there is a big multiplier effect however if extra money is withdrawn from circular flow, the multiplier effect is small
3 of 18
Multiplier equation
Multiplier (K)= 1/ 1-MPC =1/ MPW
4 of 18
Explain MPC
Marginal Propensity to Consume (mpc)- the % of any extra income that a person spends
5 of 18
Explain MPW
Marginal Propensity to Withdraw (mpw)-This is when money is withdrawn from the circular flow it includes mpt (Tax) +mpm (import) +mps (save)
6 of 18
Evaluation of fiscal policy- 1) Disincentives to work
Increasing taxes to reduce AD may cause disincentive to work, if this occurs there will be a fall in productivity and LRAS could increase at a slower rate
7 of 18
Evaluation of fiscal policy- 2) Reduced public services
Reduced government spending to reduce AD, in theory expansionary fiscal policy could help fund investment in infrastructure but it depends whether government spending is efficiently targeted to improve AS
8 of 18
Evaluation of fiscal policy- 3) poor information
to predict future inflation and growth is not easy- may be difficult to know how much to increase or decrease AD
9 of 18
Evaluation of fiscal policy- 4) Time Lags
If government plans to increase spending it could take a long time to filter into the economy
10 of 18
Evaluation of fiscal policy- 5) Increase in budget deficit
Expansionary fiscal policy will cause an increase in the budget deficit which can have an adverse effect such as higher bond yeilds
11 of 18
Evaluaation of fiscal policy- 6) Depends upon other components of AD
If consumer confidence is very low, reducing income taxes may not lead to an increase in consumer spending and fiscal policy will be ineffective in boosting demand.
12 of 18
If global economic downturn, expansionary fiscal policy may also be ineffective becasue exports (X) will be falling offsetting a rise in government spending (G)
13 of 18
Evaluation of fiscal policy- 7) Monetarist Critique
Monetarists argue that the LRAS is inelastic therefore an increase in AD will only cause inflation to increase in LR
14 of 18
Monetarists argue that extra government spending will cause crowding out. This means the extra government spending leads to a fall in private sector spending because private sector are lending to government
15 of 18
Keynesian View
Keynsian view rejects this and argues that the economy can be below full capacity for a long time therefore there would not be any crowding out because the government will be using unused resources.
16 of 18
In recession Keynesian View
In a recession, expansionary fiscal policy can play an important role in increasing real GDP
17 of 18
Evaluation of fiscal policy- 8)Depends on size of the multipler
If it is significant eg greater than 1, this means expansionary fiscal policy will be mroe effective in boosting AD
18 of 18

Other cards in this set

Card 2


The multiplier effect equation


Multiplier (K) =Changes in real GDP (Y) /Changes in injectiosn (J)

Card 3


The value of the multiplier depends on


Preview of the front of card 3

Card 4


Multiplier equation


Preview of the front of card 4

Card 5


Explain MPC


Preview of the front of card 5
View more cards


No comments have yet been made

Similar Economics resources:

See all Economics resources »See all The Mulltiplier Effect resources »