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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