en ta# 5.1 - Relevant Syllabus.

• The impact of changes in each of the components of aggregate expenditure i.e. the multiplier process using the AE model.

5.2 - Summary. §

5.3 - Content. §

5.3.1 - The concept of the multiplier. §

The multiplier (k) refers to the fact that an initial change in the level of aggregate expenditure will flow through the economy, and have a greater than proportional effect on the final level of income in the economy. For e.g., a 25B means that the multiplier is 2.5.

The multiplier applies to any autonomous change in aggregate expenditure e.g., investment, government spending, or exports.

A change in spending will either increase or decrease the initial income for a particular industry, and through spending will see further increase or decrease in income for other sectors. Therefore, change in spending has a progressive impact on the level of income in an economy. - Increase in investment spending -> increase in

Figure 9.9 saw an increase in investment spending of $10B, this:

1. Creates an additional income of $10B for the particular industry increasing output, use of resources, and employment.
2. Spending of income by households in the particular industry will create income for others.
3. The process repeats until the incremental change in income decreases to 0.

The multiplier can be calculated by:

• k = Change in Y / Change in I
• k = 1 / (1 - MPC) or 1 / MPS

For e.g., Figure 9.9 saw the total change in income after the initial 25B:

• k = 25 / 10 = 2.5

For e.g., Figure 9.9 saw the MPC being 0.6:

• k = 1 / 1 - (0.6) = 2.5

An increase in MPC would increase the ’respending’ effect and thus the size of the multiplier.

5.3.2 - The multiplier on the aggregate expenditure model. §

Working Out the Multiplier §

source

Figure 9.10 and 9.11 demonstrates an increase in investment causes the equilibrium level of income to increase by a larger amount.

Describe the economic effect of an increase in investment using Figure 9.10 and Figure 9.11:

1. The initial equlibrium amount is at Y = 300 with savings (S) and investment (I) at 60.
2. An increase in investment saw the investment schedule shifting upwards from I to I + .
3. An increase in investment also saw the C + I function shifts upwards to C + I + .
4. Each change in income will induce new spending via the marginal propensity to consume.
5. New spending will see successive increases in income at a smaller value which will further induce spending at a decreasing value until the new equilibrium.
6. The initial increase in investment of 10 saw the equilibrium level of income increase from 300 to 325.
7. The multiplier is therefore k = / = 25 / 10 = 2.5

An example of increase in AE:

• Increase in Jobseeker allowance during the pandemic.

An example of decrease in AE:

• COVID-19 pandemic decreases investment spending and a fall in GDP.

5.3.3 - The size of the multiplier. §

The size of the multiplier is determined by factors affeting the MPC.

If the MPC is greater than 0 but less than 1, the multiplier would be greater than 1. k = 1 / (1 - MPC)

If MPC = 1, the multiplier = infinity.

Factors restricting the value of MPC and therefore the size of the multiplier include the extent of leakages such as:

• Savings.
• Taxation.
• Imports.

The multiplier equation taken into account leakages:

• k = 1 / (MPS + MPT + MPM)
  • MPT: Marginal propensity to tax.

Australia’s multiplier size average between 1.5 and 2.5.

5.3.4 - Aggregate expenditure and the business cycle. §

The Keynesian aggregate expenditure can describe the economic impact of changes in any components of aggregate expenditure on the business cycle.

A decrease in autonomous expenditure (autonoumous component of AE or X, G, I) will:

1. AEf (full) will shift downwards to AE def (deflationary) representing a contractionary phase in the business cycle.
   • Aef represents the level of AE necessary to fully employ resources including labour.
   • AE def represents the level of AE after a decrease in autonomous expenditure (resources and labour are not fully utilized).
2. The multiplier effect decrease the overall levels of output, employment and income.
3. The levels of income decrease from Yf to Yd.
4. The gap between AEf (fully employ resources) and AE def is called the deflationary gap as output decreases causing a decrease in usage of labour and level of income.

An increase in autonous expenditure will:

1. AEf will shift upwards to AE inf (inflationary) representing an expansion.
2. The multiplier increases the levels of output, employment, and income.
3. The AE inf is higher than the full employment level of spending AEf, which means the economy expanded beyond its potential and so demand for inputs and final goods forces up prices.

5.4 - Questions / Thought Process. §

Is the multiplier just for increases?

Lines are functions of income.

Why doesn’t the multiplier applies to planned expenditure e.g., consumption and imports?

• Because they are independent of income and therefore adds to the consumption function, demonstrating non-price shifts.

5.5 - Resources. §

5.6 - Revision. §