The Multiplier Model

The multiplier model assumes a constant price level. It provides a graphical display and quantifies the effects of the multiplier mentioned with the AS/AD model. When expenditures are increased or decreased, they ultimately increase or decrease by more than the initial change, due to the multiplier.

 

Aggregate Production (AP)

AP is the total amount of goods and services produced in the economy. Production creates an equal amount of income, so that actual production and actual income are always equal (thus the line at 45° in the graph).

 

Aggregate Expenditures (AE)

1. AE is found the same way as the expenditure approach to GDP calculation. AE = C + I + G + (X–M)

2. Autonomous expenditures are those that would exist at a zero level of income, because they are independent of income.

3. The relationship between autonomous expenditures (AE₀), aggregate expenditures (AE), and income (Y) can be expressed as: AE = AE₀ + mpc x Y (assuming consumption is the only variable related to income).

4. The expenditure function shifts up and down when there are changes in autonomous expenditures: C, I, G, or X–M.

 

Marginal Propensity to Consume (MPC)

MPC is the ratio of the change in consumption to the change in income: mpc = change in C/change in Y. It captures the idea that people’s consumption tends to increase as their incomes increase, but not by as much as the increase in income.

 

Determining the Level of Aggregate Income

1. In equilibrium, expenditures are equal to income, which are at points of intersection between AP and AE. At such points, Aggregate Income = AE = AP.



The Multiplier Model

FIGURE 7 The multiplier model assumes a constant price level. The short-run equilibrium in the economy occurs where aggregate production (also known as aggregate income) is equal to aggregate expenditure.

2. Multiplier equation: In points of equilibrium, change in Y = change in AE = multiplier x change in AE₀, where multiplier = 1/(1–mpc)