Macroeconomics

‭up‬ ‭with‬ ‭the‬ ‭demand.‬ ‭These‬ ‭new‬ ‭employees‬ ‭now‬ ‭also‬ ‭have‬ ‭income‬ ‭to‬ ‭spend‬ ‭in‬ ‭the‬ ‭town.‬ ‭This‬ ‭cycle‬ ‭continues,‬‭with‬‭more‬‭people‬‭having‬‭jobs‬‭and‬‭spending‬‭their‬‭income,‬‭which‬‭boosts‬‭the‬‭revenues‬‭of‬‭local‬ ‭businesses.‬ ‭As‬‭the‬‭economy‬‭expands,‬‭it‬‭leads‬‭to‬‭a‬‭multiplier‬‭effect.‬ ‭The‬‭initial‬‭increase‬‭in‬‭investment‬ ‭and‬ ‭spending‬ ‭by‬ ‭the‬ ‭factory‬ ‭ripples‬ ‭through‬ ‭the‬ ‭economy,‬ ‭creating‬ ‭more‬ ‭jobs‬ ‭and‬ ‭income‬ ‭for‬ ‭the‬ ‭community. This, in turn, generates even more spending and economic growth.‬ ‭So,‬‭the‬‭multiplier‬‭effect‬‭occurs‬‭when‬ ‭an‬‭initial‬‭injection‬ ‭into‬‭the‬‭circular‬‭flow‬‭of‬‭income‬ ‭causes‬‭a‬‭larger‬ ‭fnal‬ ‭increase‬ ‭in‬ ‭real‬ ‭national‬ ‭income‬ ‭(real‬ ‭GDP)‬ ‭.‬‭Recall‬‭that‬‭injections‬‭into‬‭the‬‭circular‬‭flow‬‭include‬ ‭investment,‬‭government‬‭spending,‬‭and‬‭exports‬‭since‬‭they‬‭increase‬‭spending‬‭in‬‭an‬‭economy.‬‭This‬‭effect‬ ‭is‬‭calculated‬‭using‬‭the‬ ‭multiplier‬ ‭,‬‭which‬‭is‬‭the‬ ‭ratio‬‭of‬‭the‬‭change‬‭in‬‭the‬‭equilibrium‬‭level‬‭of‬‭output‬‭to‬ ‭a change in some autonomous variable‬ ‭.‬ ‭An‬ ‭autonomous‬ ‭or‬ ‭exogenous‬ ‭variable‬ ‭is‬ ‭one‬ ‭that‬ ‭does‬ ‭not‬ ‭change‬‭with‬‭a‬‭change‬‭in‬‭income‬ ‭or‬‭real‬ ‭GDP.‬‭In‬‭other‬‭words,‬‭it‬‭does‬‭not‬‭depend‬‭on‬‭the‬‭state‬‭of‬‭the‬‭economy‬‭nor‬‭does‬‭it‬‭change‬‭in‬‭response‬‭to‬ ‭changes‬ ‭in‬‭the‬‭economy.‬‭For‬‭example,‬‭governments‬‭spend‬‭money‬‭when‬‭they‬‭have‬‭a‬‭reason‬‭to‬‭(e.g.,‬‭to‬ ‭build‬‭a‬‭bridge),‬‭not‬‭because‬‭they‬‭have‬‭additional‬‭income‬‭to‬‭spend.‬‭In‬‭this‬‭case,‬‭government‬‭spending‬‭is‬ ‭an‬‭autonomous‬‭variable.‬‭To‬‭calculate‬‭the‬‭multiplier,‬‭we‬‭need‬‭to‬‭learn‬‭two‬‭crucial‬‭concepts‬‭frst:‬‭MPC‬‭and‬ ‭MPS.‬ ‭Marginal Propensities to Consume and Save (MPC and MPS)‬ ‭Typically,‬ ‭individuals‬ ‭tend‬ ‭to‬ ‭spend‬ ‭a‬ ‭portion‬ ‭of‬ ‭their‬ ‭income‬ ‭and‬ ‭set‬ ‭aside‬‭the‬‭remainder‬‭as‬‭savings.‬ ‭Therefore,‬ ‭any‬ ‭additional‬ ‭dollar‬ ‭gained‬ ‭in‬ ‭income‬ ‭will‬ ‭be‬ ‭either‬ ‭spent‬ ‭or‬ ‭saved.‬ ‭To‬ ‭calculate‬ ‭this‬ ‭proportion,‬ ‭we‬ ‭use‬ ‭the‬ ‭marginal‬ ‭propensity‬ ‭to‬ ‭consume‬ ‭(MPC)‬ ‭and‬ ‭the‬ ‭marginal‬ ‭propensity‬ ‭to‬ ‭save‬ ‭(MPS).‬ ‭1.‬ ‭The‬ ‭marginal‬ ‭propensity‬‭to‬‭consume‬‭(MPC)‬ ‭calculates‬ ‭the‬‭proportion‬‭of‬‭extra‬‭income‬‭that‬‭is‬ ‭spent‬ ‭.‬

‭=‬ ‭ ℎ ‬‭‬‭ ‬‭‬‭ ‭ ℎ ‬‭‬‭ ‬‭‬‭ ‬ ‬ ‭∆‬‭ ‭∆‬‭ ‬ ‬

‭MPC =‬

‭Note that ∆ denotes a change.‬

‭Assume‬‭that‬‭following‬‭an‬‭increase‬‭in‬‭income‬‭by‬‭$100,‬‭an‬‭individual‬‭spent‬‭an‬‭additional‬‭$80‬‭on‬ ‭consumption.‬ ‭Therefore,‬ ‭MPC‬ ‭=‬ ‭80/100‬ ‭=‬ ‭0.8.‬ ‭In‬ ‭practical‬ ‭terms,‬ ‭this‬ ‭means‬ ‭that‬ ‭for‬ ‭every‬ ‭additional $1 earned, $0.8 is spent on consumption.‬ ‭●‬ ‭The‬‭MPC‬‭is‬‭a‬‭critical‬‭concept‬‭in‬‭economics‬‭because‬‭it‬‭helps‬‭us‬‭understand‬‭how‬ ‭changes‬ ‭in income affect consumer spending and, in turn, overall economic activity‬ ‭.‬ ‭●‬ ‭The‬ ‭value‬ ‭of‬ ‭the‬ ‭MPC‬ ‭for‬ ‭the‬ ‭whole‬ ‭economy‬ ‭must‬ ‭be‬ ‭between‬ ‭0‬ ‭and‬ ‭1‬ ‭because‬ ‭consumers‬‭might‬‭spend‬‭some‬‭(0‬‭<‬‭MPC‬‭<‬‭1),‬‭none‬‭(MPC‬‭=‬‭0),‬‭or‬‭all‬‭of‬‭their‬‭increases‬‭in‬ ‭incomes (MPC = 1).‬

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