EXPENDITURE
MULTIPLIERS
Fixed Prices and Expenditure Plans
Expenditure Plans
The four components of aggregate expenditure—
consumption expenditure, investment, government
purchases of goods and services, and net exports—sum
to real GDP.
Aggregate planned expenditure equals planned
consumption expenditure plus planned investment plus
planned government purchases plus planned exports
minus planned imports.
Fixed Prices and Expenditure Plans
A two-way link exists between aggregate expenditure and
real GDP:
An increase in real GDP increases aggregate
expenditure
An increase in aggregate expenditure increases real
GDP
Fixed Prices and Expenditure Plans
Consumption Function and Saving Function
Consumption and saving are influenced by:
The real interest rate
Disposable income
Wealth
Expected future income
Disposable income is aggregate income (GDP) minus
taxes plus transfer payments.
Fixed Prices and Expenditure Plans
To explore the two-way link between real GDP and
planned consumption expenditure, we focus on the
relationship between consumption expenditure and
disposable income when the other factors are constant.
The relationship between consumption expenditure and
disposable income, other things remaining the same, is
the consumption function.
And the relationship between saving and disposable
income, other things remaining the same, is the saving
function.
Fixed Prices and
Expenditure Plans
Figure 10.1 illustrates the
consumption function and
the saving function.
Fixed Prices and Expenditure Plans
Marginal Propensities to Consume and Save
The marginal propensity to consume (MPC) is the fraction
of a change in disposable income spent on consumption.
It is calculated as the change in consumption expenditure,
C, divided by the change in disposable income, YD, that
brought it about.
That is:
MPC = C/ YD
Fixed Prices and Expenditure Plans
The marginal propensity to save (MPS) is the fraction of a
change in disposable income that is saved.
It is calculated as the change in saving, S, divided by the
change in disposable income, YD, that brought it about.
That is:
MPS = S/ YD
Fixed Prices and Expenditure Plans
The MPC plus the MPS equals one.
To see why, note that,
C + S = YD.
Divide this equation by YD to obtain,
C/ YD + S/ YD = YD/ YD,
or
MPC + MPS = 1.
Fixed Prices and
Expenditure Plans
Slopes and Marginal
Propensities
Figure 10.2 shows that the
MPC is the slope of the
consumption function and
the MPS is the slope of
the saving function.
Fixed Prices and
Expenditure Plans
Other Influences on
Consumption
Expenditure and Saving
When an influence other
than disposable income
changes—the real
interest rate, wealth, or
expected future income—
the consumption function
and saving function shift.
Figure 10.3 illustrates
these effects.
Fixed Prices and Expenditure Plans
Import Function
In the short run, imports are influenced primarily by U.S.
real GDP.
The marginal propensity to import is the fraction of an
increase in real GDP spent on imports.
In recent years, NAFTA and increased integration in the
global economy have increased U.S. imports.
Removing the effects of these influences, the U.S.
marginal propensity to import is probably about 0.2.
Real GDP with a Fixed Price Level
Equilibrium Expenditure
Equilibrium expenditure is the level of aggregate
expenditure that occurs when aggregate planned
expenditure equals real GDP.
The Multiplier
The multiplier is the amount by which a change in
autonomous expenditure is magnified or multiplied to
determine the change in equilibrium expenditure and real
GDP.
The Multiplier
The Basic Idea of the Multiplier
An increase in investment (or any other component of
autonomous expenditure) increases aggregate
expenditure and real GDP and the increase in real GDP
leads to an increase in induced expenditure.
The increase in induced expenditure leads to a further
increase in aggregate expenditure and real GDP.
So real GDP increases by more than the initial increase in
autonomous expenditure.
The Multiplier
Figure 10.7 illustrates the
multiplier.
The Multiplier Effect
The amplified change in
real GDP that follows an
increase in autonomous
expenditure is the
multiplier effect.
The Multiplier
When autonomous
expenditure increases,
inventories make an
unplanned decrease, so
firms increase production
and real GDP increases to
a new equilibrium.
The Multiplier
Why Is the Multiplier Greater than 1?
The multiplier is greater than 1 because an increase in
autonomous expenditure induces further increases in
expenditure.
The Size of the Multiplier
The size of the multiplier is the change in equilibrium
expenditure divided by the change in autonomous
expenditure.
The Multiplier
The Multiplier and the Marginal Propensities to
Consume and Save
Ignoring imports and income taxes, the marginal
propensity to consume determines the magnitude of the
multiplier.
The multiplier equals 1/(1 – MPC) or, alternatively,
1/MPS.
The Multiplier
Imports and Income Taxes
Income taxes and imports both reduce the size of the
multiplier.
Including income taxes and imports, the multiplier equals
1/(1 – slope of the AE curve).
The Multiplier
Figure 10.9 shows the
relation between the
multiplier and the slope of
the AE curve.
In part (a) the slope of the
AE curve is 0.75 and the
multiplier is 4.
The Multiplier
In part (b) the slope of the
AE curve is 0.5 and the
multiplier is 2.
The Multiplier
Business Cycle Turning Points
Turning points in the business cycle—peaks and troughs
—occur when autonomous expenditure changes.
An increase in autonomous expenditure brings an
unplanned decrease in inventories, which triggers an
expansion.
A decrease in autonomous expenditure brings an
unplanned increase in inventories, which triggers a
recession.
EXPENDITURE
MULTIPLIERS
THE
END
