Lecture Notes: Multiplier and Accelerator Effects in Macroeconomics

Introduction

• Advanced theories in macroeconomics: Multiplier and Accelerator
• Important for essays and understanding economic growth

Multiplier Effect

Definition

• Multiplier: Process where changes in components of Aggregate Demand (AD) lead to greater changes in National Output.
• An increase in AD shifts AD curve to the right, increasing national output.
• Multiplier effect implies further increase beyond initial shift due to a cycle of income and spending.

Mechanism

• Initial spending increases income, leading to further spending by others.
• Creates a virtuous cycle of income and spending.
• AD continuously shifts right, increasing National Output beyond initial spending.

Calculation

• Multiplier formula: ( \text{Multiplier} = \frac{1}{1 - \text{MPC}} )

  • MPC (Marginal Propensity to Consume): Proportion of additional income spent.
  • Range between 0 (none spent) and 1 (all spent).
  • Example: If extra income is £50 and £25 is spent, MPC = 0.5.

• Alternatively, use ( \text{Multiplier} = \frac{1}{\text{MPW}} )

  • MPW (Marginal Propensity to Withdraw): Proportion of income not consumed (savings, taxes, imports).

Example

• Government injects £100 million, MPC = 0.8:
  • Initial spend £100 million, then £80 million spent, continues...
  • Multiplier = ( \frac{1}{1-0.8} = 5 )
  • Final GDP change: £100 million x 5 = £500 million
  • Multiplier effect adds £400 million to National Output.

Diagram and Impact

• Diagram: AD shifts from AD1 to AD2 to AD3 due to multiplier.
• Final equilibrium further to the right than initial shift only.

Determinants of Multiplier Size

• Higher MPC = Larger Multiplier
• Factors reducing MPC:
  • High saving rates
  • High taxation
  • High import spending

Accelerator Effect

Definition

• Accelerator: Links changes in investment to changes in GDP growth rate.
• Focuses on firm investment, not consumer spending.

Mechanism

• Faster GDP growth rate encourages more investment.
• Firms invest more when they expect future demand to be high.
• Slowing or negative GDP growth reduces investment.

Impact

• Higher GDP growth rate increases investment, enhancing growth.
• Slowing GDP growth reduces investment, decreasing AD and GDP growth.

Application

• Both effects explain business cycle dynamics.

Conclusion

• Understanding multiplier and accelerator effects essential for analyzing economic fluctuations and growth cycles.
• Utilize these theories in economic analyses and essays.