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Principles of Macroeconomics


Expenditure Multipler


In this section we learn how changes in spending plans are magnified to even larger changes in aggregate income and spending. Spending plans includes consumption (consumer's decisions for purchases of final goods and services), investment (producer's decisions for purchasing and building capital), government spending on final goods and services, and net exports. Changes in spending are magnified, because when one economic agent decides to spend one dollar more, that becomes an additional dollar of income for another economic agent. In turn, that economic agent saves part of that dollar, and spends part of that dollar. The amount he or she spends, becomes income for someone else, and the cycle continues. This expenditure multiplier model can be used to explain why macroeconomic fluctuates. Small shocks to people's spending plans result in larger changes in macroeconomic activity.


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Deriving the Expenditure Multipler

In this Pencast, we show mathematically how a one dollar change in planned expenditure leads to changes in aggregate consumption and aggregate imports. We show mathematically, how much each of these change, and how much real GDP changes as a result. We derive a formula for the expenditure multipler which shows how much real GDP increases (decreases) when planned expenditure increases (decreases) by one dollar. [Play Pencast]


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Example: Increase in Consumption

Here we show how to use the multiplier to predict how much real GDP will change when there is a boost in consumer confidence changes consumption plans. [Play Pencast]


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Example: Decrease in Investment

Here we show how to use the multiplier to predict how much real GDP will change when a change in businesses' outlook for the future leads to a decrease in investment. [Play Pencast]


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Changes in the Multiplier

Here we discuss what factors can lead to a change in the expenditure multiplier, and what are the consequences to economic stability. The factors that affect the multiplier are consumers' marginal propensity to save and the marginal propensity to import. When either of these are higher, the amount of an additional dollar of income that someone spends domestically is lower. This mutes the multipler effect. [Play Pencast]


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