Business Cycle, Short Run Growth, The Multiplier & Accelerator Effects

Draw & Label this diagram with what you recall from AS Economics

Objectives Understand the concept of the ‘output gap’ Be able to explain how the relationship between the ‘output gap’ and short term and long term economic growth Be able to explain the economic theory behind multiplier and accelerator effects To be confident in calculating multiplier effect

The Output Gap The difference between actual GDP and it’s trend value In other words the actual level of output minus the potential level Negative = trough Positive = peak

Growth and the Output Gap

New normal growth rate likely to be slow .............

A permanent loss of output UK GDP still well below the peak before the last recession..............

Trend growth is falling – why? Recession may have inflicted damage on trend growth

AD/AS & Short Run Growth

AD & AS through a business cycle

Multiplier Effect : “the ratio of a change in equilibrium real income to the autonomous change that brought it about ; it is calculated as 1/mpw (marginal propensity to withdraw)” In other words when workers see their income increase, it is the proportion of the increase that is spent and therefore benefits the economy Marginal Propensity withdraw : “the sum of marginal propensities to save, tax, import – the proportion of additional income that is withdrawn from the circular flow”

Worked example of multiplier Households save 5% Households spend 10% of imports Households are taxed 25% MPW = s+m+t = ? Multiplier effect = 1/mpw = ? The larger the multiplier, the bigger the AD shift

Work out this example Households save 10% Households import 15% Households tax 30% What is the marginal propensity to withdraw? What is the multiplier effect?

The accelerator effect “a theory by which the level of investment depends upon the change in real output” As economic growth increases in recovery, firms invest more. As the cyclical growth slows, firms reduce investment Works in tandem with multiplier. Firms invest, increases income of workers who spend some in the economy, leads to growth, leads to further investment