Chapter 11 The Output Multiplier Online Texts com

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Chapter 11 The Output Multiplier © Online. Texts. com p. 1

Chapter 11 The Output Multiplier © Online. Texts. com p. 1

The multiplier effect • When an autonomous component of Aggregate Demand changes, equilibrium output

The multiplier effect • When an autonomous component of Aggregate Demand changes, equilibrium output (Y) will change. • The change in output will be even larger than the initial change in Aggregate Demand. • This result for the change in Y to be greater than the initial change in Aggregate Demand is known as the multiplier effect. © Online. Texts. com p. 2

Calculating the Size of the Multiplier Effect • The size of the multiplier effect

Calculating the Size of the Multiplier Effect • The size of the multiplier effect is given by: where the (simple) output multiplier is defined as 1/(1 -MPC). © Online. Texts. com p. 3

The simple output multiplier • The simple output multiplier assumes – there are no

The simple output multiplier • The simple output multiplier assumes – there are no proportional taxes – all expenditures are for domestically produced goods and services – the price level is fixed © Online. Texts. com p. 4

How and Why the Multiplier Works • When Aggregate Demand rises, output and hence

How and Why the Multiplier Works • When Aggregate Demand rises, output and hence income rise. • The rise in income allows people to consume more goods and services. • This is called "income-induced" consumption and it raises Aggregate Demand even more. © Online. Texts. com p. 5

Example: University builds a new residence hall worth $100 million. MPC=0. 8 © Online.

Example: University builds a new residence hall worth $100 million. MPC=0. 8 © Online. Texts. com p. 6

The Output Multiplier with Proportional Taxes • A proportional tax is a tax that

The Output Multiplier with Proportional Taxes • A proportional tax is a tax that varies with the level of income (e. g. income tax). – If income is taxed at a 20 percent rate, then t = 0. 20. • The formula for the output multiplier when proportional taxes are present, is: © Online. Texts. com p. 7

Proportional taxes reduce the size of the multiplier effect. © Online. Texts. com p.

Proportional taxes reduce the size of the multiplier effect. © Online. Texts. com p. 8

The Output Multiplier with Imports • When income rises, demand foreign goods and services

The Output Multiplier with Imports • When income rises, demand foreign goods and services also rises, lowering the demand for U. S. goods & services and dampening the multiplier effect. • The marginal propensity to import (MPI) is the change in imports divided by the change in disposable income. • The output multiplier without proportional taxes but accounting for imports is: © Online. Texts. com p. 9

The Output Multiplier with Price Level Change • For this slide only, we relax

The Output Multiplier with Price Level Change • For this slide only, we relax the assumption that the price level is fixed. • When the AD curve shifts and the AS curve is upward sloping, the multiplier effect is smaller. • The economy moves from point A to point C, instead of point B. © Online. Texts. com p. 10

The Multiplier Effect and a Temporary Change in Aggregate Demand • If the change

The Multiplier Effect and a Temporary Change in Aggregate Demand • If the change in Aggregate Demand is temporary, then the change in output is temporary. • Examples include road or building repairs. © Online. Texts. com p. 11

The Multiplier Effect and a Temporary Change in Aggregate Demand • Equilibrium output rises

The Multiplier Effect and a Temporary Change in Aggregate Demand • Equilibrium output rises initially, but the impact dampens out over time. © Online. Texts. com p. 12

The Multiplier Effect and a Permanent Change in Aggregate Demand • If the change

The Multiplier Effect and a Permanent Change in Aggregate Demand • If the change in Aggregate Demand is permanent, the equilibrium level of output in the economy is permanently higher. • Examples: new school or prison. © Online. Texts. com p. 13

The Multiplier Effect and a Permanent Change in Aggregate Demand • The overall equilibrium

The Multiplier Effect and a Permanent Change in Aggregate Demand • The overall equilibrium level of output in the economy rises by the initial change in AD times the size of the output multiplier. © Online. Texts. com p. 14

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