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Understanding Multiplier and Accelerator Theories

Apr 24, 2025

Macroeconomics: Multiplier and Accelerator Theories

Introduction

  • Advanced macroeconomic theories: Multiplier and Accelerator.
  • Useful for essays and understanding macroeconomic changes.

The Multiplier Effect

  • Definition: A process where changes in aggregate demand (AD) lead to a greater change in national output.
  • Diagram Explanation: An increase in AD shifts to the right, increasing national output from Y1 to Y2, but the actual effect will extend beyond Y2 due to the multiplier effect.

How the Multiplier Works

  • Increase in spending → Generates income → Facilitates further spending → Continuation in a cycle.
  • AD shifts more than initial spending increase, settling at a greater national output.

Measuring the Multiplier

  • Equation: 1 / (1 - Marginal Propensity to Consume, MPC).
    • MPC: The fraction of additional income that is spent.
    • Values range from 0 (none spent) to 1 (all spent).
  • Alternative: 1 / Marginal Propensity to Withdraw (savings, taxation, imports).

Example Calculation

  • Government injects £100 million.
  • If MPC = 0.8, Multiplier = 1 / (1 - 0.8) = 5.
  • Final GDP change = 5 * £100 million = £500 million.*

Diagram Representation

  • Price level vs Real GDP.
  • Government spending shifts AD from AD1 to AD2, increasing output by £100 million.
  • Multiplier effect shifts AD further, increasing output to £500 million.

Determinants of Multiplier Size

  • Factors:
    • MPC size: Larger MPC increases multiplier.
    • Saving culture: Higher savings reduce MPC and multiplier.
    • Taxation: High taxes reduce multiplier.
    • Imports: High propensity to import reduces multiplier.

The Accelerator Effect

  • Focus: Investment, unlike the consumer spending focus of the multiplier.
  • Concept: Changes in investment are linked to changes in the rate of GDP growth.

How the Accelerator Works

  • Increasing GDP growth rate encourages firm investment due to optimistic future demand.
  • Positive Effect: Increased investment accelerates GDP growth.
  • Negative Effect: Decreasing or negative GDP growth rate leads to reduced investment, slowing GDP growth.

Relation to Business Cycle

  • Both Multiplier and Accelerator explain the business cycle's shape.
  • Importance in understanding economic expansions and contractions.

Conclusion

  • Both theories are crucial for understanding macroeconomic dynamics and can be used to explain economic cycles.

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