Explain the multiplier + how it is calculated
Macroeconomics is the study of the decisions and performances of an entire economy, and the multiplier effect is something that governments need to think about when intervening to shift aggregate demand. Aggregate demand is the total demand for all goods and services in an economy. The multiplier effect is an effect that says an initial expenditure injection into the business cycle will multiply as it provides money for consumers to consume and contribute into the market and shifts the aggregate demand, thus increase the national income of the nation. The effect also states that the resulting benefit will be a multiple of the initial amount injected.
The formula to find the multiplier is:
The resulting final amount /initial injection into market
The value of the multiplier also depends on the marginal propensity to consume (MPC), the portion spent of each additional income from the injection. This is figured by dividing the total amount of additional income by the amount consumed from the additional income. The higher this number, the higher the value of the multiplier will be.
The diagram above explains the benefits of the multiplier effect as the AD shifts from government injection. At first the economy is at a GDP of Y1, at price P1 and with AD1. The initial injection shifts the AD curve from AD1 to ADg, and increases the GDP from Y1 to Yg. Then, in the long term the injected expenditure further multiplies as it provides additional income to labor, money for capital investment, and further consumption. This shifts the AD curve from ADg to AD2, and increases the GDP from Yg to Y2. The multiplier is Y1-Y2/Yg-Y1.
Filed under: Section 3, Year 2 Tagged: | Aggregate demand, economics, government intervention, Macroeconomics, Multiplier effect, Test review
