1. Aggregate Expenditures: The multiplier Part 2 of Unit 3 Krugman Section 4 Module 21

2. The Multiplier Effect  Small change in investment leads to a large change in output and income.  The multiplier determines how large the change will be  Multiplier = change in GDPr / initial change in spending  Ex. A $5 billion change in Ig led to a $20 billion change in GDP.  What is the multiplier? 4444

3. Rationale  The economy has continuous flows of expenditure & income—ripple effect  Income received by person A comes from $ spent from person B.  The fraction of the change in income that is spent is called the MPC  The fraction of the change in income that is saved is called the MPS

4. Multiplier & Marginal Propensities  The size of the MPC and the multiplier are directly related  The size of the MPS & the multiplier are inversely related  Spending Multiplier  M = 1 / MPS  or  M = 1 / (1-MPC)

5.  Tax Multiplier  -MPC/MPS  OR -MPC/ (1-MPC)  **note the negative sign (when the G taxes, we have less DI = less C)

6. Significance of the Multiplier  A small change in investment plans or consumption savings plans can trigger a much larger change in the equilibrium level of GDP

7. Magic of the Multiplier Packet

8. Check for understanding What could happen to C Savings and/or DIg?  1. The threat of limited war, leading the public to expect future shortages of durables. (C,S)  2. A decline in the real interest rate. (all)  3. A sharp, sustained decline in stock prices. (C,S)  4. The development of a cheaper method of manufacturing computer chips. (Ig)

9.  5. A sizable increase in the retirement age for collecting social security benefits. (C,S)  6. The expectation of an increase in the CPI for the next two years. (C,S)  7. The overall feeling of the nation is one of optimism. (all)  8. An increase in the federal income tax. (C,S)

10.  1. The threat of limited war, leading the public to expect future shortages of durables. (C,S)  C increase S decrease  Multiplier would increase  2. A decline in the real interest rate. (all)  Ig increase (movement) C increase S decrease  Multiplier would increase  3. A sharp, sustained decline in stock prices. (C, S)  C decrease S increase  Multiplier would decrease  4. The development of a cheaper method of manufacturing computer chips. (Ig)  Ig increase (technology)  Multiplier would increase

11.  5. A sizable increase in the retirement age for collecting social security benefits. (C,S)  C decrease S increase  Multiplier would decrease  6. The expectation of an increase in the CPI for the next two years. (C,S)  C increase S decrease  Multiplier would increase  7. The overall feeling of the nation is one of optimism. (all)  C increase S decrease Ig increase  Multiplier would increase  8. An increase in the federal income tax. (C,S)  C decrease S decrease  **the exception to the increase of one means the decrease of the other**  Multiplier would decrease