1. THE MACRO ECONOMIC MULTIPLIER
Deriving and illustrating

2. Injections into the circular flow cause changes in the equilibrium level of output
The change is sometimes bigger than the injection eg R1 of G spending results in R2 of Y and E in the economy
How and why this happens is explained using the macro economic multiplier

3. Assume the basic model
That means only firms and consumers in this economy
Therefore E= C + I
Y= C + S
The economy is in equilibrium: E = Y
and L = J

4. The Keynesian 45 degree diagram

5. The 45 degree line shows all points where E = Y

6. The expenditure functionsa0

7. The expenditure function is represented by the line E = C + I
this shows total spending by households and firms
When either C or I increases it causes the E function to shift up
The amount of the shift is illustrated by
a0a1 while the increase in output is Y0Y1

8. Numerical example C = a + bY C = 10 + 0.5Y I = 10
C is made up of 2 parts
10 is the amount they always spend with or without income (autonomous spending)
0.5 represents how much of each Rand of income they spend (b also determines the gradient)

9. If consumers spend 0.5 of each Rand, it means they save the other 0.5
This number refers to their marginal propensity to consume (mpc)
A high mpc means consumers are likely to spend more than save
So if C = and I = 10 then
E =
That means E = Y

10. The gradient of the expenditure function is determined by bY (0.5)
The intersection with the 45degree line will show the equilibrium level of real output
The value of this amount is calculated as follows:
Y = Y
Therefore: 20 = 0.5Y thus Y = 40

11. Assume businesses decide to increase I by 10
This will push E up to Y
The E curve will shift up and will result in an increase in Y from 40 to 60
Thus an increase in E of just 10 results in the double the increase in Y (20)

12. Size of the gradient
The value of bY (mpc) determines the slope of the gradient
If the mpc is 0.7, the E function will have a steeper slope, will cut the 45 degree line higher up and result in larger increases in Y.
From previous example:
C Y + I 20 becomes 30 = 0.3Y
THUS the equilibrium level of Y here is 90