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Chapter 10

Chapter 10. The Multiplier, Net Exports, & Government. Introduction. We will examine why is GDP unstable and subject to cyclical fluctuations. We will also introduce the Government & the foreign sector into the aggregate spending model.

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Chapter 10

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  1. Chapter 10 The Multiplier, Net Exports, & Government

  2. Introduction • We will examine why is GDP unstable and subject to cyclical fluctuations. • We will also introduce the Government & the foreign sector into the aggregate spending model. • We will then apply the model into both the Vietnam War & the Great Depression

  3. Changes in Equilibrium & the Multiplier • GDP responds to changes in both consumption & investment. The primary focus for this chapter will be investment • Increase in investment spending leads to an exponential increase in equilibrium GDP. • This is known as the Multiplier Effect

  4. Continuing the Multiplier • Initial change in spending is usually associated w/ investment due to volatility • The “initial change” is represented by upward or downward movement on the graph (Aggregate Expenditure Schedule) • Multiplier works in both directions (up or down)

  5. Basic Facts of the Multiplier • The Economy has continuous flows of expenditures and income – a ripple effect • Change in income will cause consumption and savings to change in the same direction • The size of the MPC and the Multiplier are directly related, the MPS is inversely related to the multiplier

  6. Significance • Small changes in investment plans or consumption can trigger large changes in equilibrium GDP. • Simple Multiplier vs. Complex • Simple does not include the effect of savings, taxes, & imports

  7. Net Exports • Positive Net Exports increase aggregate spending and then GDP as well • Negative Net Exports decrease both • What relationship would tariffs have on GDP? • What about depreciation of the dollar? • Prosperity abroad typically indicates prosperity at home.

  8. Questions • What is the multiplier effect? • What relationship does the MPC bear to the size of the multiplier? The MPS? • Calculate the multiplier if the MPS is 0, .4, .6, and 1 • Calculate the multiplier if MPC is 1, .9, .67, .50, and 0 • How much will GDP increase if investment increases 8 billion and the MPC is .8? • What is the difference between the complex & simple multiplier?

  9. The Public Sector • Government spending boosts aggregate expenditures yet reduce disposable income • Government purchases also subject to the multiplier • Taxes will cause disposable income to fall short • How short is determined by multiplying the MPC and MPS by the total tax revenue

  10. Injections, Leakage, & Unplanned Inventory • Savings, Imports, Taxes are all considered leakages to the stream of spending • Investments, Exports, & Government Purchases are all considered injections • At equilibrium GDP, these two will equal each other (Injections = Leakages @ =GDP)

  11. Balanced Budget Multiplier • Equal increases in Government spending and taxation increase the equilibrium GDP. • Changes in government spending affects aggregate spending more powerfully than a tax change of the same size. • Balanced Budget Multiplier is always one

  12. Equilibrium & Full GDP • Recessionary gaps exists when equilibrium GDP is below full employment GDP. In other words, we are capable of making more • Inflationary Gaps exist when aggregate expenditures cannot achieve equilibrium at full employment.

  13. Limitations of the Model • The Aggregate Spending model does not measure inflation – It will show an inflationary gap, it will not however show the exact price level increase • Does not allow for GDP to increase once full employment is reached • Does not allow for cost push inflation

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