Chapter 28 Notes

# Chapter 28 Notes - [ChapterTwentyEight TheMultiplierModel...

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[Chapter Twenty Eight] The Multiplier Model Learning Objectives After reading the material in this chapter, you will be able to do the following: 1. Explain the difference between induced and autonomous expenditures. 2. Show how the level of income is graphically determined in the multiplier model. 3. Use the multiplier equation to determine equilibrium income. 4. Explain how the multiplier process amplifies shifts in autonomous expenditures. 5. Demonstrate how fiscal policy can eliminate recessionary and inflationary gaps. 6. List seven reasons why the multiplier model might be misleading. Chapter Outline The Multiplier Model The Multiplier Model: “A model that emphasizes the effect of fluctuations in aggregate demand, rather than the price level, on output.” Up until the inflation of the 1970s, the multiplier model was the central model of macroeconomics. The AS / AD model downplays dynamic feedbacks. The multiplier model builds them in, portraying an aggregate economy that is locally unstable but globally stable; output does not tend to gravitate toward a single equilibrium. For small fluctuations in aggregate demand, most economists believe that the AS / AD model provides a better sense of how the macroeconomy operates; for large fluctuations, such as occurred in 2008, the multiplier model gives a better sense of what is happening.

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Axel Leijonhufvud argues that policy makers should work with two models of the aggregate economy— one for normal times and one for times of crisis. Aggregate Production Aggregate Production ( AP ): “The total amount of final goods and services produced in every industry in an economy.” Actual income and actual production are always equal. Graphically, the aggregate production curve (or aggregate income curve) in the multiplier model is a 45° line on a graph, with real income in dollars on the horizontal axis and real production in dollars on the vertical axis. The 45° line connects all of the points where aggregate production and aggregate income are equal. Figure 28-1 shows an aggregate production curve. The model is only relevant when output is below its potential. Aggregate Expenditures Aggregate Expenditures: “The total amount of spending on final goods and services in the economy.” This consists of consumption, investment, government spending, and net exports. In the multiplier model, we focus on the four components’ relationship to income. To keep the exposition simple, we focus on the aggregate relationship between all expenditure components combined and income. Autonomous and Induced Expenditures Autonomous Expenditures: “Expenditures that do not systematically vary with income.” Induced Expenditures: “Expenditures that change as income changes.” The empirical relationship between income and aggregate expenditures is represented with the aggregate expenditures (AE) curve. For simplicity, it is usually a straight line, as in Figure 28-2.
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Chapter 28 Notes - [ChapterTwentyEight TheMultiplierModel...

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