Multiplier and Accelerator Theories Explained

Hi everyone. The multiplier and accelerated theories. Advanced kind of theories when it comes to macroeconomics, but theories you should be able to use in your essays. Let's start by looking at the multiplier. The multiplier is a process by which any changes in the components of aggregate demand will lead to an even greater change in national output. Very simply, we've learned so far that any increase in AD, you picture the diagram in your head, will shift aggregate demand, obviously, to the right and increase national output from Y1 to Y2. So growth will increase on our diagram. We've said that. The multiplier effect goes one stage further and says that the actual effect on growth will not stop at Y2. There'll be a further increase in growth as well. That is the multiplier effect. Now, how does that happen? Well, very simply, if you break this down, all the multiplier is saying is that any increase in spending by aggregate demand going up, for whatever reason, that is an increase in spending, will create income for somebody else, which will then facilitate spending by those people, which will create income for somebody else, which will facilitate further spending by those people, which will create more income and more spending and more income and more spending. You get into this virtuous cycle. And the end effect is that... that 80 doesn't just shift to the right because of that initial amount of spending, but actually it keeps shifting to the right before settling on a much greater change in national output than the initial increase in spending. We can always measure the multiplier as well, and the equation for the multiplier is this. 1 over 1 minus the marginal propensity to consume. Now what is the marginal propensity to consume? It's just very simply, out of each extra pound that's being generated in terms of income, how much is actually going to be... spent. So the MPC can take a range of values between 0 and 1, where 1 represents 100% of that extra pound is being spent, right? And 0 is that none of that extra pound is being spent. gain an extra £50 worth of income and I decide to spend £25 of that extra income, my MPC would be 0.5. We can also measure it going the other way. Instead of 1 over 1 minus the MPC, we could just look at 1 over the marginal propensity to withdraw. That's just the opposite. So instead of you consuming that extra pound, how much are you not consuming basically? How much are you taking away from it? from the economy, either in terms of savings, in terms of taxation, in terms of spending on imports. So that is the same as the marginal propensity to save plus the marginal propensity to tax plus the marginal propensity to import. All the different ways, instead of spending your money, you could be taking your money out of the circular flow of income. We could also measure it using this equation, which is exactly the same as that one if you think about it. Let's take an example here. Let's say that we have a company that is say that the government decides to spend some money. So let's say government decides to inject £100 million into the economy. Now we know on a diagram that's going to shift a little to the right, but the final effect will not just stop at that increase in growth, there will be a further increase in growth. as a result of the multiplier effect. So, let's say that from that 100 million pounds, every time income is generated, 80% of that income is spent. All right, so that initial increase of 100 million pounds. The first time, £80 million will be spent, because £100 million of income is being generated. £80 million will then be spent. Whoever then receives that £80 million, 80% of that will be spent again. Whoever receives that spending, that income, 80% will be spent again. So, we're going to assume here that the marginal propensity to consume is therefore equal to 0.8. Now, immediately, when we have this... We can then work out the multiplier value, and then we can work out what the final change in real GDP will be. And it won't just be an increase of 100 million. It will actually be more than that. So let's have a look. 1 minus, sorry, 1 over 1 minus 0.8, which is 1 over 0.2. And that gives you the value of 5. And that is our multiplier effect. And what we do with that is we times the multiplier by the initial increase in spending. is 100 million. So 5 times 100 million gives you 500 million pounds. And that's the final change in output. That's the final increase in national output as a result of this initial increase in spending. Yes? So basically 400 million pounds is the value of the multiplier in this sense. It's how much extra national output is increased as a result of the multiplier effect. Now we can actually show that on a diagram. So. On a diagram, let's take that example. So we have here the price level, and let's just go real GDP. Let's take a Keynesian BOM and aggregate supply curve. And let's say AD initially was over here at 81. Price level P1 and output level Y1. Now that was the initial level of output. We've just said government spending has increased by 100 million. And we know that's going to shift AD to the right to AD2. And that will increase growth. And growth will increase from Y1 to Y2. Let's be more specific. Let's say that is... Y1 plus that 100 million pounds. So that increase from Y1 to Y1 plus 100 million is just the government spending impact. But now we're saying, well, the multiplier effect will mean AD keeps shifting. Income is... being generated for somebody else which will facilitate further spending etc etc and we settle on an output level which is actually y1 plus 500 million so you can see how AD keeps shifting to the right and you get a settling equilibrium which is much further to the right than the initial increase in spending, which only takes us to 82. That is the multiplier effect, and specifically this final shift here is the multiplier, right there. So that's how you control the multiplier effect on a diagram. What I also want to briefly talk about is what can determine the size of the multiplier. So the bigger the value of the multiplier, the more the final change in real GDP will be, obviously. But, what determines that value? Well, very simply, it's the MPC. So, the bigger the MPC, the bigger the multiplier. The smaller the MPC, the smaller the multiplier. Now, what can determine the MPC? Well, if in the economy, people tend to save. If there is a culture of saving, then that MPC will fall smaller and will lead to a smaller multiplier value. If there is a lot of tax in the economy, taxation levels are very high, that's going to reduce the MPC. overall multiplier value. If the marginal propensity to import, if people like to, when they gain income, spend a lot of it on imports, that's going to reduce the value of the MPC. So what determines the value of the multiplier? Basically the size of these factors, the level of saving, the level of import expenditure, the level of taxation in the economy. If any of those three are very high, or all of them are very high, that's going to reduce the multiplier value. Okay, great. Let's also now look at the accelerator effect, which is another high level concept when it comes to macroeconomics. The accelerator is a very simple effect. Multiplier is all about consumer spending, how much extra spending takes place when initial spending actually occurs, when an initial increase in AD occurs. The accelerator looks more at investment, looks at firms spending money, not consumers spending money. So the accelerator is this, it says that changes in investment can be directly linked to changes in the rate of GDP growth. The key word there is rate. And all it says very simply is when the rate of GDP growth is actually increasing, then firms are going to be more willing to invest. You can imagine that there will be an increase in investment at the same time. Why? Because firms are bullish. They think that demand is going to be high in the future, growth is going to be high in the future, it's going to be increasing rapidly. Now is a good time to invest in new capital. Now is a good time to spend money on maybe expanding my factory or investing in new office space or moving into a new office premise. premises, whatever it might be, they invest their money and that is as a direct result of expected future rates of growth. However, if the rate of GDP growth starts to slow down or it starts to go negative, the opposite will be true. Firms will stop investing and hold back and that's going to reduce aggregate demand. So with higher rates of GDP growth, that is likely to be speedened up, quickened by an increase in investment. But, the reason But if the rate of GDP growth starts to slow down, starts to fall, or go negative, then firms will hold back on investing, cut their investment expenditure, and that will push AD down. So that will facilitate even quicker decreases in the rate of GDP. growth. Both effects here can be used, multiply and accelerate, to explain the shape of the business cycle. I've explained that in my more advanced economic cycle video. Alright, that's it. Multiply and accelerate is done. Thanks for watching. See you next time.

Hi everyone. The multiplier and accelerated theories. Advanced kind of theories when it comes to macroeconomics, but theories you should be able to use in your essays.

Let's start by looking at the multiplier. The multiplier is a process by which any changes in the components of aggregate demand will lead to an even greater change in national output. Very simply, we've learned so far that any increase in AD, you picture the diagram in your head, will shift aggregate demand, obviously, to the right and increase national output from Y1 to Y2. So growth will increase on our diagram.

We've said that. The multiplier effect goes one stage further and says that the actual effect on growth will not stop at Y2. There'll be a further increase in growth as well. That is the multiplier effect.

Now, how does that happen? Well, very simply, if you break this down, all the multiplier is saying is that any increase in spending by aggregate demand going up, for whatever reason, that is an increase in spending, will create income for somebody else, which will then facilitate spending by those people, which will create income for somebody else, which will facilitate further spending by those people, which will create more income and more spending and more income and more spending. You get into this virtuous cycle.

And the end effect is that... that 80 doesn't just shift to the right because of that initial amount of spending, but actually it keeps shifting to the right before settling on a much greater change in national output than the initial increase in spending. We can always measure the multiplier as well, and the equation for the multiplier is this.

1 over 1 minus the marginal propensity to consume. Now what is the marginal propensity to consume? It's just very simply, out of each extra pound that's being generated in terms of income, how much is actually going to be... spent. So the MPC can take a range of values between 0 and 1, where 1 represents 100% of that extra pound is being spent, right?

And 0 is that none of that extra pound is being spent. gain an extra £50 worth of income and I decide to spend £25 of that extra income, my MPC would be 0.5. We can also measure it going the other way.

Instead of 1 over 1 minus the MPC, we could just look at 1 over the marginal propensity to withdraw. That's just the opposite. So instead of you consuming that extra pound, how much are you not consuming basically?

How much are you taking away from it? from the economy, either in terms of savings, in terms of taxation, in terms of spending on imports. So that is the same as the marginal propensity to save plus the marginal propensity to tax plus the marginal propensity to import. All the different ways, instead of spending your money, you could be taking your money out of the circular flow of income.

We could also measure it using this equation, which is exactly the same as that one if you think about it. Let's take an example here. Let's say that we have a company that is say that the government decides to spend some money.

So let's say government decides to inject £100 million into the economy. Now we know on a diagram that's going to shift a little to the right, but the final effect will not just stop at that increase in growth, there will be a further increase in growth. as a result of the multiplier effect.

So, let's say that from that 100 million pounds, every time income is generated, 80% of that income is spent. All right, so that initial increase of 100 million pounds. The first time, £80 million will be spent, because £100 million of income is being generated. £80 million will then be spent.

Whoever then receives that £80 million, 80% of that will be spent again. Whoever receives that spending, that income, 80% will be spent again. So, we're going to assume here that the marginal propensity to consume is therefore equal to 0.8. Now, immediately, when we have this... We can then work out the multiplier value, and then we can work out what the final change in real GDP will be.

And it won't just be an increase of 100 million. It will actually be more than that. So let's have a look.

1 minus, sorry, 1 over 1 minus 0.8, which is 1 over 0.2. And that gives you the value of 5. And that is our multiplier effect. And what we do with that is we times the multiplier by the initial increase in spending. is 100 million. So 5 times 100 million gives you 500 million pounds.

And that's the final change in output. That's the final increase in national output as a result of this initial increase in spending. Yes? So basically 400 million pounds is the value of the multiplier in this sense.

It's how much extra national output is increased as a result of the multiplier effect. Now we can actually show that on a diagram. So. On a diagram, let's take that example. So we have here the price level, and let's just go real GDP.

Let's take a Keynesian BOM and aggregate supply curve. And let's say AD initially was over here at 81. Price level P1 and output level Y1. Now that was the initial level of output. We've just said government spending has increased by 100 million. And we know that's going to shift AD to the right to AD2.

And that will increase growth. And growth will increase from Y1 to Y2. Let's be more specific.

Let's say that is... Y1 plus that 100 million pounds. So that increase from Y1 to Y1 plus 100 million is just the government spending impact.

But now we're saying, well, the multiplier effect will mean AD keeps shifting. Income is... being generated for somebody else which will facilitate further spending etc etc and we settle on an output level which is actually y1 plus 500 million so you can see how AD keeps shifting to the right and you get a settling equilibrium which is much further to the right than the initial increase in spending, which only takes us to 82. That is the multiplier effect, and specifically this final shift here is the multiplier, right there.

So that's how you control the multiplier effect on a diagram. What I also want to briefly talk about is what can determine the size of the multiplier. So the bigger the value of the multiplier, the more the final change in real GDP will be, obviously. But, what determines that value?

Well, very simply, it's the MPC. So, the bigger the MPC, the bigger the multiplier. The smaller the MPC, the smaller the multiplier.

Now, what can determine the MPC? Well, if in the economy, people tend to save. If there is a culture of saving, then that MPC will fall smaller and will lead to a smaller multiplier value.

If there is a lot of tax in the economy, taxation levels are very high, that's going to reduce the MPC. overall multiplier value. If the marginal propensity to import, if people like to, when they gain income, spend a lot of it on imports, that's going to reduce the value of the MPC. So what determines the value of the multiplier? Basically the size of these factors, the level of saving, the level of import expenditure, the level of taxation in the economy.

If any of those three are very high, or all of them are very high, that's going to reduce the multiplier value. Okay, great. Let's also now look at the accelerator effect, which is another high level concept when it comes to macroeconomics. The accelerator is a very simple effect. Multiplier is all about consumer spending, how much extra spending takes place when initial spending actually occurs, when an initial increase in AD occurs.

The accelerator looks more at investment, looks at firms spending money, not consumers spending money. So the accelerator is this, it says that changes in investment can be directly linked to changes in the rate of GDP growth. The key word there is rate. And all it says very simply is when the rate of GDP growth is actually increasing, then firms are going to be more willing to invest. You can imagine that there will be an increase in investment at the same time.

Why? Because firms are bullish. They think that demand is going to be high in the future, growth is going to be high in the future, it's going to be increasing rapidly.

Now is a good time to invest in new capital. Now is a good time to spend money on maybe expanding my factory or investing in new office space or moving into a new office premise. premises, whatever it might be, they invest their money and that is as a direct result of expected future rates of growth. However, if the rate of GDP growth starts to slow down or it starts to go negative, the opposite will be true. Firms will stop investing and hold back and that's going to reduce aggregate demand.

So with higher rates of GDP growth, that is likely to be speedened up, quickened by an increase in investment. But, the reason But if the rate of GDP growth starts to slow down, starts to fall, or go negative, then firms will hold back on investing, cut their investment expenditure, and that will push AD down. So that will facilitate even quicker decreases in the rate of GDP.

growth. Both effects here can be used, multiply and accelerate, to explain the shape of the business cycle. I've explained that in my more advanced economic cycle video. Alright, that's it.

Multiply and accelerate is done. Thanks for watching. See you next time.

Transcript for:Multiplier and Accelerator Theories Explained

Transcript for:
Multiplier and Accelerator Theories Explained