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.