• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Use the multiplier to explain how an increase in any component of aggregate demand will increase GDP. What are the practical problems in trying to determine the exact size of a multiplier effect?

Extracts from this document...


Use the multiplier to explain how an increase in any component of aggregate demand will increase GDP. What are the practical problems in trying to determine the exact size of a multiplier effect? Under what circumstances will a positive multiplier effect not be advantageous for an economy? Any time new spending is introduced into or removed from an economy, it will cause GDP to change by some multiple of the spending shock. This takes place through the multiplier process in aggregate spending largely through changes in consumption expenditure. Therefore the principle of the multiplier is that a change in the level of injections of leakages brings about a relatively greater change in the level of national income. The level of change depends greatly on consumers' marginal propensity to consume (MPC)- how much additional income will they spend or save-, the larger the MPC is, the larger the multiplier effect and so the biggest change to GDP. As economic activity starts to increase economic agents may become more optimistic about economic prospects and thence firms increase investment and consumers spends more. Therefore the pace of recovery is magnified. Equally small initial downturns in the economy may be greatly increased as negative expectations are often self-fulfilling and create decreased aggregate spending and reduced economic activity. ...read more.


Workers may also contribute a portion of their income to a pension plan. It is also incredibly difficult to calculate a consumer's MPC because consumers do not always have the same tastes and something as trivial as the season may change a consumer's MPC, so even if a successful result is achieved it is likely to change and be inaccurate very quickly. In addition, collecting this information may be very hard as survey's will have to be carried out and this is often unreliable, it could be done by looking at an individual's additional income and the amount they spend, however, this is also impractical because it is such a small scale and there is a great diversity between consumers' habits in an economy. Economists, such as Michael Kalecki, have found differences between the MPC of those who earned wages or salaries and those who live off unearned income. He showed that these differences in MPC mean that income distribution can greatly affect the value of the multipliers and therefore the national income equilibrium. If a successful calculation cannot be found for the multiplier then an accurate determination of the effect cannot be scaled. In addition, inflation may make it difficult to identify the multiplier in a real economy. ...read more.


of the economy is such that even though there is spare capacity there is no flexibility of labour, this could be applied to any of the factors of production. The multiplier may also not cause growth for an economy as increased consumer spending may lead to more goods and services being imported from outside the domestic economy, in this situation the marginal propensity to import rises and the positive multiplier effect will not be totally realised because expected increases in aggregate demand will not materialise. In addition, regional differences in the economy can also mean that a positive multiplier effect does not lead to the economy benefiting because a rise in incomes in one area may result in consumption from another, therefore regional divides will become only more pronounced. In conclusion, an initial change in AD can have a greater final impact on equilibrium national income in the operation of the multiplier effect. There are problems in calculating the multiplier effect mainly to do with the ceteris paribus in that the key assumptions of the simple multiplier are not applicable to the real world economy. Finally, in the situation where the economy is at full capacity this is the main state in which the multiplier operating positively will have negative implications for the economy. Ali Llewellyn K 1 ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our GCSE Economy & Economics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related GCSE Economy & Economics essays

  1. Peer reviewed

    Define "The multiplier effect" and explain how it works. Using practical examples of how ...

    4 star(s)

    This is usually done from investment expenditure, government spending or exports. For example if the government increases expenditure in education, this allows to increase expenditure to all other things relating to education as well, such as teacher salaries, new school buildings, school equipment, computer facilities etc.

  2. Labour is a derived demand because the demand for labour is a result of ...

    Production and demand for labour will also increase if a firm is experiencing high sales. The level of output of a firm is influenced by many factors, the most important being the general economic conditions, the pattern of consumer demand and the demand for the individual firm's output.

  1. An Empirical Investigation into the Causes and Effects of Liquidity in Emerging

    As a secondary objective, the fund seeks capital appreciation, when consistent with its primary objective. The criteria for inclusion in this index is for fixed income securities that are rated Baa, or lower, by Moody's Investors Services, or BBB, or lower, by Standard & Poor's.

  2. Why do some small Firms Grow in size?

    be sold during a peak, and buses can be sold during a recession, thus protecting itself against a fluctuating economy. Equally, a small firm may want to go into the production of a good which is complementary to its primary good, this would also require a growth in the firm's size.

  1. Aggregate Demand and Aggregate Supply.

    As soon as the aggregate demand decreases the aggregate supply must also decrease. The Monetarists followed Say's Law which argues that the government should stimulate production rather them consumption and that aggregate supply is determined by supply-side factors. Factors such as: change in raw materials, change in wages and change

  2. What is aggregate demand? Explain what determines the main components of aggregate demand?

    banks, building societies and other lending agencies. A rise in interest rates leads to a fall in consumer consumption on goods, which are primarily bought on credit e.g.

  1. How Can British Airways Increase Profitability?

    This has led to a situation of producer surplus. Producer surplus is the difference between the price consumers are prepared to pay and the price at which firms are prepared to supply their goods. Pricing Policies British Airways operates a policy of differentiate prices between customers.

  2. Should the government increase spending to get out of a recession?

    Then there are the ethical issues attached with globalised business; the rich gain at the expense of the poor20. Localisation provides domestic jobs, consumer choice and directly contributes to real GDP, which is only advantageous. Small businesses do not tend to have the large expenditure needed to operate globally, and

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work