Maths_Trial_Paper

* The simple multiplier: k = 1/(1-MPC) * Changing levels of growth: the multiplier * Whenever savings (S) is not equal to investment (I), the economy will be disrupted from its state of equilibrium. The Circular flow model suggests that the economy will move towards a state of equilibrium (it would move towards equilibrium at a higher level of economic activity hen the injection of I is greater than the leakage S, and at a lower level of economic activity when injection I is than leakage S * The concept takes place by the multiplier process: * When there is a shock to the economy (i.e. changes in consumer or business expectations, interest rates or government policies, there will be a change in injections and leakages. E.g. lower interest rates will increase business investment and expenditure which would provide increased income for individuals, who hen consume more, which will further increase expenditure and income and so on. This process does not continue forever as each time the injection moves around the economy, its impact on expenditure gets smaller as part of the income is saved rather than consumed (MPS). This savings component is a leakage that reduces the effect of the higher investment on national income * The multiplier is the number of times the trial increase in national income exceeds the initial increase in expenditure that is caused (e.g. if aggregate demand increased by $1000 and through the multiplier process the national income rose by $10000, the multiplier would be 10) * To calculate how changes in injection or leakage has a multiplied impact on income we need to consider two more concepts * The Marginal Propensity to Consume (MPC), which is the proportion of each extra dollar (increase in disposable income) of income that is spent on goods and services * The Marginal Propensity to Save (MPS), which is the proportion of each extra dollar (increase in disposable income) of income that is saved * MPC+MPS=1 * MPC= Change in conpsumtion Chane in income MPS=Change in SavingsChange in income * Explaining the concept of multiplier process * Assume that for each extra dollar of income, consumers spend 80% (80 cents) and sav 20% (20 cents) * MPC = 0.8 * MPS = 0.2 * Assume also that investment in the economy has increased by $10000. This represents an injection into the circular flow of $10000, or in other words an initial increase in aggregate demand of $10000. This excess in aggregate demand will manifest itself in an unplanned rundown of stocks. Produces will respond by increasing output and national income will initially increase by $10000 * National income will increase by the initial $10000 * Of the $10000, $8000 will be spent (since MPC = 0.8)while $2000 will be saved (MPS = 0.2) * The $8000 that is spent will be income to those who receive it as payment for goods & services * Of the $8000, $6400 will be spent (0.8 x *000), while $1600 will be saved * The $6400 that is spent will be income to those who receive it. They in turn spend 80% of it and save 20% and so on * The final increase in national income is equal to the initial increase in AD multiplied by the ‘Multiplier’ * The size of the multiplier is determined by the MPS and can be expressed as: K= 1MPS or 11-MPC * Under the conception that MPS = 0.2 K= 1MPS=10.2=5 * The total increase in income generated by the $10000 increase in AD is: ∆Y = K ×∆AD=5 ×$10000=$50000 * If individuals save proportionately more of their extra income, they will spend less and therefore generate less additional income Copyright (c) Tim DIxon's Economic book