11.5 Changes in Equilibrium GDP and the Multiplier

What is the multiplier formula in the AE model?

Multiplier = change in real GDP / initial change in spending

What is the alternate formula for the multiplier?

Multiplier = 1 / MPS

MPS = Marginal Propensity to Save

What does the multiplier tell us?

It shows how a small change in spending (especially investment) causes a larger change in GDP.

In the example, if investment increases by $5B and GDP rises by $20B, what is the multiplier?

Multiplier = 20/5 = 4

If MPS = 0.25, what is the multiplier?

Multiplier = 1/0.25 = 4

What causes the AE schedule to shift upward?

An increase in planned investment (𝐼𝑔), often due to higher expected returns or lower interest rates.

What happens when the AE schedule shifts upward?

Equilibrium GDP increases — spending rises, inventories fall, firms expand production.

What causes the AE schedule to shift downward?

A decrease in planned investment, often due to lower expected returns or higher interest rates.

What happens when the AE schedule shifts downward?

Equilibrium GDP decreases — spending drops, inventories rise, firms cut production.

Why does equilibrium GDP change more than the initial investment change?

Because of the multiplier effect — each dollar of new spending circulates and creates more income and spending.

What restores equilibrium after a change in investment?

The economy adjusts until saving equals planned investment and there are no unplanned inventory changes.

What is the role of saving in the multiplier process?

Saving is a leakage — the economy must generate enough new income to match the initial investment and restore equilibrium.

The multiplier effect means that….

There is a bigger change in equilibrium GDP than the change in aggregate expenditures

So equilibrium GDP changes in response to changes in either the ________________

Because changes in the investment schedule are the main sources of instability, we direct our attention toward them.

Consumption schedule (C) or the investment schedule Ig