Macro 3.2 Spending Multipliers and GDP

Introduction to GDP Multipliers and Marginal Propensities

  • The video presents an overview of GDP multipliers and marginal propensities.

  • Encouragement to visit ReviewEcon.com for additional resources such as the Total Review Booklet.

Key Definitions

Disposable Income

  • Definition: The income available for consumers to spend or save after taxes.

  • Formula: Disposable Income = Personal Income - Taxes.

  • Components: Consumer spending and consumer savings add up to form household disposable income.

  • Example:

    • Income: $100,000

    • Taxes: $20,000

    • Disposable Income: $80,000

    • Savings: $8,000

    • Spending: $72,000

Average Propensities

  • Definition: Tendency of consumers to either save or spend disposable income.

Average Propensity to Save (APS)

  • Formula: APS = Savings / Disposable Income

  • Example:

    • Savings: $8,000

    • Disposable Income: $80,000

    • APS = 0.1

Average Propensity to Consume (APC)

  • Formula: APC = Spending / Disposable Income

  • Example:

    • Spending: $72,000

    • Disposable Income: $80,000

    • APC = 0.9

  • APS + APC = 1

Marginal Propensities

Marginal Propensity to Consume (MPC)

  • Definition: The percentage of additional income that is spent rather than saved.

  • Formula: MPC = Change in Spending / Change in Income

  • Example:

    • Income change: $20,000 (from $80,000 to $100,000)

    • Spending change: $115,000 (from $72,000 to $887,000)

    • MPC = $115,000 / $20,000 = 0.75

Marginal Propensity to Save (MPS)

  • Definition: The percentage of additional income saved rather than spent.

  • Formula: MPS = Change in Savings / Change in Income

  • Example:

    • Income change: $20,000

    • Savings change: $5,000 (from $8,000 to $13,000)

    • MPS = $5,000 / $20,000 = 0.25

Impact on the Economy: Spending Multiplier

  • Definition: The ratio of change in GDP to the initial change in spending.

Example: Islandia

  • Situation:

    • MPC: 0.8

    • MPS: 0.2

  • Original Spending: $800 (from Victor's purchase of a canoe) leads to a chain of spending throughout the economy, ultimately causing GDP to increase significantly.

  • Spending Multiplier Calculation:

    • Formula: Spending Multiplier = 1 / MPS

    • In this case: 1 / 0.2 = 5

    • Results in total GDP increase: $800 * 5 = $4,000

Other Examples of Spending and Impact on GDP

  1. Gross Investment:

    • MPC: 0.75, change in spending: $10,000

    • Multiplier: 4 → total increase: $10,000 * 4 = $40,000

  2. Government Spending:

    • MPS: 0.1, change: -$5 million

    • Multiplier: 10 → total decrease: -$5 million * 10 = -$50 million

  3. Net Exports:

    • MPC: 0.95, change: -$1 million

    • Multiplier: 20 → total decrease: -$1 million * 20 = -$20 million

Tax Multiplier

  • Definition: The impact of tax changes on the overall economy and how it affects disposable income.

  • Formula: Tax Multiplier = -MPC / MPS or -MPC / (1 - MPC)

  • Example:

    • MPC: 0.8, MPS: 0.2

    • Tax Multiplier: -0.8 / 0.2 = -4

    • Change: -$10 million in taxes → increase in GDP = -$10 million * -4 = $40 million

Balanced Budget Multiplier

  • Definition: Impacts of equal changes in government spending and taxes.

  • Formula: Balanced Budget Multiplier = 1

  • Example:

    • Increase by $10 million in both taxes and spending

    • Net effect: $10 million impact on GDP

Advanced Examples

Working Backwards

  • Output gap scenario with MPC: 0.9, MPS: 0.1, current GDP: $150 million, potential GDP: $200 million.

  • Gap: -$50 million, government spending needed: $50 million / 10 = $5 million increase.

Combination of Actions Example

  • MPC: 0.9, MPS: 0.1, parameters for net exports and taxes.

  • Net effect calculation: 45 billion - 40 billion = $5 billion increase in GDP.

Conclusion

  • Understanding GDP multipliers, marginal propensities, and their impact on economics is essential for exam success.

  • Practice recommended, and resources available on ReviewEcon.com.