1. Multiplier Macroeconomics

2. In Macroeconomics, it is important to understand the following relationships:
Disposable income and consumption
Disposable income and saving
The interest rate and investment
Changes in spending and changes in real GDP

3. The Relationship Between Income and Consumption
Disposable (after-tax) income equals
savings (S) plus consumption (C).
Economists define personal saving as “not spending” or “that part of disposable income not consumed.”

4. The Consumption Schedule or “Consumption Function”
In the aggregate, households increase their spending as their disposable income rises and spend a larger proportion of a small disposable income than of a large disposable income.

5. Many factors determine the nation’s levels of consumption and saving, but the most significant is disposable income.

6. The Saving Schedule or “Saving Function”
There is a direct relationship between saving and disposable income but saving is a smaller proportion of a small DI than of a large DI. Households consume a smaller and smaller proportion of DI as DI increases; therefore, they must be saving a larger and larger proportion.

7. Dissaving (consuming in excess of after-tax income) will occur at relatively low DIs.
Households can consume more than their incomes by liquidating (selling for cash) accumulated wealth or by borrowing.

8. Non income Determinants of Consumption and Saving (Other than disposable income, what else effects consumption and saving?)
Wealth
Expectations
Real Interest Rates
Household Debt
Taxation

9. Changes in wealth, expectations, interest rates, and household debt will shift consumption in one direction and saving in the opposite direction.
In contrast, a change in taxes will result in consumption and saving moving in the same direction. A tax increase shifts both downward, and a tax decrease shifts them upward.
Income minus taxes = Disposable Income

11. Marginal Propensity to Consume (MPC)
The proportion, or fraction, of any change in income consumed is called the marginal propensity to consume (MPC). The MPC is the ratio of a change in consumption to a change in the income that caused the consumption change.
MPC = change in consumption
change in income

12. Marginal Propensity to Save (MPS)
The fraction of any change in income saved is the marginal propensity to save (MPS). The MPS is the ratio of a change in saving to the change in income that brought it about:
MPS = change in saving
change in income

13. Marginal Propensities
How much of every additional dollar in income is consumed? MPC
How much of every additional dollar iin income is saved? MPS
MPC + MPS = $1 of additional income
.: MPC = 1 – MPS
.: MPS = 1 – MPC
Remember, people do two things with their disposable income, consume it or save it!

14. THE SPENDING MULTIPLIER (Sometimes called the expenditures multiplier)
When C or Ig or G or Xn increases, real GDP also increases.
But the total increase in real GDP is larger than the initial increase in spending.
The multiplier is the amount by which a change in any component of spending is magnified or multiplied to determine the change that it generates in real GDP.
There are several ways to approach the derivation of the multiplier. The most accessible way to launch your lecture is allow students to “get their hands dirty” by performing a couple of quick calculations. Ask your students to assume that your classroom is a small city and that you are interested in building a brand new factory there. Assume that the initial expenditure will be $100 million. Pretend to write out a check to the first general contractor (a student in the first row). This contractor will pay the workers, the next student. (You can explain to the class that you are assuming everything is constructed using only labor for simplicity. Nothing changes except adding complications if you take account of intermediate inputs.) Ask the class to assume that everyone’s marginal propensity to consume is 0.9. So the first worker will spend $90 million in total. You can either ask the stuChapter dent what he or she would buy or you can suggest an item, such as cars. In any case, the student spends the income by handing it to the very next student, who, coincidentally manufactures cars or whatever the student buys. So the $90 million in expenditure is income to the next student who, in turn, will spend $81 million. You can continue these rounds as spending through as many iterations as you want. But, regardless of the number, have the class keep a running tally of all the spending and income that is created from the initial expenditure.
[Continued on next slide]

15. The Ripple Effect
INTERACTIVE GRAPHIC: A look at how one business closing changed the spending habits of just one person - OrlandoSentinel.com

16. The Multiplier Effect
A change in spending ultimately changes output and income by more than the initial change in investment spending. This is called the multiplier effect.

18. Calculating the Spending Multiplier
The Spending Multiplier can be calculated from the MPC or the MPS.
Multiplier = 1/1-MPC or 1/MPS
Multipliers are (+) when there is an increase in spending and (–) when there is a decrease in spending
You multiply the multiplier times the initial increase in spending to determine total effect on real GDP.

19. MPS, MPC, & Multipliers
Ex. Assume U.S. citizens spend 90¢ for every extra $1 they earn. Further assume that the real interest rate (r%) decreases, causing a $50 billion increase in gross private investment. Calculate the effect of a $50 billion increase in IG on U.S. Aggregate Demand (AD).
Step 1: Calculate the MPC and MPS
MPC = ΔC/ΔDI = .9/1 = .9
MPS = 1 – MPC = .10
Step 2: Determine which multiplier to use, and whether it’s + or -
The problem mentions an increase in Δ IG .: use a (+) spending multiplier
Step 3: Calculate the Spending and/or Tax Multiplier
1/MPS = 1/.10 = 10
Step 4: Calculate the Change in AD
(Δ C, IG, G, or XN) * Spending Multiplier
($50 billion Δ IG) * (10) = $500 billion ΔAD

20. Calculating the Tax Multiplier
When the government increases or decreases taxes, the multiplier is determined using a different formula because tax increases or tax decreases will change disposable income.
Tax Multiplier (note: it’s negative if it is a tax increase)
= -MPC/1-MPC or -MPC/MPS
If there is a tax-CUT, then the multiplier is +, because there is now more money in the circular flow

21. MPS, MPC, & Multipliers
Ex. Assume Germany raises taxes on its citizens by €200 billion . Furthermore, assume that Germans save 25% of the change in their disposable income. Calculate the effect the €200 billion change in taxes on the German economy.
Step 1: Calculate the MPC and MPS
MPS = 25%(given in the problem) = .25
MPC = 1 – MPS = = .75
Step 2: Determine which multiplier to use, and whether it’s + or -
The problem mentions an increase in T .: use (-) tax multiplier
Step 3: Calculate the Spending and/or Tax Multiplier
-MPC/MPS = -.75/.25 = -3
Step 4: Calculate the Change in AD
(Δ Tax) * Tax Multiplier
(€200 billion Δ T) * (-3) = -€600 billion Δ in AD

22. The Balanced Budget Multiplier
When Government spending increases are matched with an equal increase in taxes (to balance the budget), the resulting change in real GDP ends up being = to the change in Government spending
Why?
1/MPS + -MPC/MPS = 1- MPC/MPS = MPS/MPS = 1
The balanced budget multiplier always = 1
1 times the increase in Government spending = Total impact on real GDP

23. MPS, MPC, & Multipliers
Ex. Assume the Japanese spend 4/5 of their disposable income. Furthermore, assume that the Japanese government increases its spending by ¥50 trillion and in order to maintain a balanced budget simultaneously increases taxes by ¥50 trillion. Calculate the effect the ¥50 trillion change in government spending and ¥50 trillion change in taxes on Japanese Aggregate Demand.
Step 1: Calculate the MPC and MPS
MPC = 4/5 (given in the problem) = .80
MPS = 1 – MPC = = .20
Step 2: Determine which multiplier to use, and whether it’s + or -
The problem mentions an increase in G and an increase in T .: combine a (+) spending with a (–) tax multiplier
Step 3: Calculate the Spending and Tax Multipliers
Spending Multiplier = 1/MPS = 1/.20 = 5
Tax Multiplier = -MPC/MPS = -.80/.20 = -4
Step 4: Calculate the Change in AD
[ Δ G * Spending Multiplier] + [ Δ T * Tax Multiplier]
[(¥50 trillion Δ G) * 5] + [(¥50 trillion Δ T) * -4]
[ ¥250 trillion ] + [ ¥200 trillion ] = ¥50 trillion Δ AD

24. How Large is the Actual Multiplier Effect?
The Council of Economic Advisers, which advises the U.S. President on economic matters, has estimated that the actual multiplier effect for the United States is about 2.