3-27 Notes - Chapter 8 The Multiplier Model What is a...

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Chapter 8 The Multiplier Model What is a Multiplier Model? A multiplier effect – or, more completely, the spending/income multiplier effect – occurs when a change in spending causes a disproportionate change in aggregate demand . For example, how shocks to investment, foreign trade, and government tax and spending policies can affect output and employment in an economy. Assumptions in basic multiplier model: Wages and prices are fixed There are unemployed resources Determination of Equilibrium (What are the demand and supply?) Supply of the final goods: actual final goods produced (e.g. bread, computers, airplanes, etc.) Y=aggregate income Demand of the final goods: aggregate expenditure Z=Aggregate expenditure= C+I+G+X-M, under closed economy assumption Z= C+I+G Assume that C= co + c1(Y - T) (depends on disposable income), c1 is the MPC I, G fixed level Z = co + c1(Y - T) + I + G Equilibrium will occur when Demand=Supply, i.e. aggregate income = aggregate expenditure.
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