1. Principles and Policies I: Macroeconomics
Chapter 10: The Multiplier Model
Macroeconomics, Maclachlan /1/04

2. Chapter 10 Learning Objectives You should be able to …
Explain the difference between induced and autonomous expenditures.
Show how the level of income is graphically determined in the multiplier model.
Use the multiplier equation to determine equilibrium income.
Explain how the multiplier process amplifies shifts in autonomous expenditures.
Demonstrate how fiscal policy can eliminate recessionary and inflationary gaps.
List six reasons why the multiplier model might be misleading.
Macroeconomics, Maclachlan /1/04

3. The AS/AD Model When Prices Are Fixed
Real output
Price level
Induced shift
(Multiplier effects)
Initial shift 20 AD AD P0
Aggregate supply ?
Cumulative shift
Macroeconomics, Maclachlan /1/04

4. Macroeconomics, Maclachlan 11/1/04
The Circular Flow
Macroeconomics, Maclachlan /1/04

5. The Aggregate Production Curve
Real production
Real income
Aggregate production
(production = income) B C A
$4,000
$4,000
45º
Potential income
Macroeconomics, Maclachlan /1/04

6. Macroeconomics, Maclachlan 11/1/04
Multipler Model
Aggregate Production curve meets …
Aggregate Expenditure
= C + I + G + (X-M)
Macroeconomics, Maclachlan /1/04

7. Macroeconomics, Maclachlan 11/1/04
Building Aggregate Expenditure Function: Autonomous and Induced Expenditures
Autonomous expenditures – expenditures that do not systematically vary with income.
Induced expenditures – expenditures that change as income changes.
Macroeconomics, Maclachlan /1/04

8. Macroeconomics, Maclachlan 11/1/04
Building Aggregate Expenditure Function: The Marginal Propensity to Expend
Marginal propensity to expend (mpe) – the ratio of the change in aggregate expenditures to a change in income.
It is composed of the various relationships between the component of aggregate expenditures.
Its value is greater than 0 and less than 1.
It is the slope of the aggregate expenditure curve.
Macroeconomics, Maclachlan /1/04

9. Expenditures Function
Autonomous expenditures is the sum of the autonomous components of expenditures:
AE0 = C0 + I0 + G0 + (X0 – M0)
Induced expenditures is the sum of the induced components of expenditures.
Macroeconomics, Maclachlan /1/04

10. Solving for Equilibrium Graphically
Real income (in dollars)
Real expenditures (AE) (in dollars)
Aggregate production
14,000
12,000
Aggregate expenditures
10,000
AE = 5, Y
Equilibrium
7,000
5,000
AE0 = 5,000
4,000
10,000
14,000
Macroeconomics, Maclachlan /1/04

11. The Multiplier Equation
Expenditures multiplier – a number that reveals how much income will change in response to a change in autonomous expenditures.
Macroeconomics, Maclachlan /1/04

12. The Circular Flow Model and the Multiplier Process
Not all of the flow of income is spent on domestic goods (the mpe < 1).
This represents a leakage from the circular flow.
Autonomous expenditures are injections into the circular flow.
They offset the leakages.
Macroeconomics, Maclachlan /1/04

13. Macroeconomics, Maclachlan 11/1/04
The First Five Steps
mpe = .4
mpe = .5
100
100 50 40 25 16
6.4
2.56
12.5
6.25
Multiplier = 1/(1-0.4) = 1.7
Multiplier = 1/(1-0.5) = 2
Macroeconomics, Maclachlan /1/04

14. Macroeconomics, Maclachlan 11/1/04
An Upward Shift of AE
Real expenditures
Real income
Aggregate production
1,052.5
AE1
$4,210 30
1,022.5
AE0
4,090
$4,090
$120
Macroeconomics, Maclachlan /1/04

15. Macroeconomics, Maclachlan 11/1/04
An Downward Shift of AE
Real expenditures
Aggregate production
AE0
1,412
$4,152
AE1
1,382 30
$4,062
4,062
$90
Real income
Macroeconomics, Maclachlan /1/04

16. Fighting Recession: Expansionary Fiscal Policy
Potential
output
Aggregate production
AE0
AE1 E1
mpe = 0.67
Recessionary gap
∆G = $60
$1,000
$1,180
Real income
AE1 = Y
SAS
LAS
AD1
AD0 E2
AD1΄
$180
$60
$120
Initial expenditures increase
Multiplier effect
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

17. Fighting Inflation: Contractionary Fiscal Policy
Potential
output
Aggregate production
AE0
AE1 E2
mpe = 0.8 E1
Inflationary gap
∆G = $200
$4,000
$5,000
Real income
AE1 = Y B A
SAS
LAS
AD0
AD1 P1 P0
$1,000
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

18. Limitations of Multiplier Model
It’s incomplete: needs info on where economy starts and potential output.
It over emphasizes shifts in AE.
It assumes a fixed price level.
It doesn’t consider expectations.
It ignores possibility of desired shifts in AE.
It ignores permanent income hypothesis.
Macroeconomics, Maclachlan /1/04

19. Macroeconomics, Maclachlan 11/1/04
Problem 10-1
The mpe is 0.8. Autonomous expenditures are $4,200. What is the equilibrium income in the economy?
$21,000
Macroeconomics, Maclachlan /1/04

20. Macroeconomics, Maclachlan 11/1/04
Problem 10-4
mpe = .6
Multiplier = 2.5
A = 1, ,000 +
10, ,000
= 20,000
Y = 50,000
Increase in A of 2,000
Y increases by 5,000 (or 10%)
Unemployment decreases by 5 percentage points.
mpe = .5
Multiplier = 2
Y= 40,000
Y increases by 4,000 (or 10%)
Unemployment decreases by 5 percentage points.
Macroeconomics, Maclachlan /1/04