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Chapter 23: Problem 12

An \(M P C\) equal to 0 implies a multiplier of 1 , meaning that \(\$ 1\) increase in autonomous expenditures would increase real GDP by only \(\$ 1 .\) Why does an \(M P C\) equal to 0 result in no multiplier effect? Conversely, an MPC equal to 1 implies an infinite multiplier, meaning that a \(\$ 1\) increase in autonomous expenditures would increase real GDP by an infinite amount. Why does an \(\mathrm{MPC}\) of 1 result in an infinite multiplier? Explain your answers using the logic of the multiplier process.

Short Answer

Expert verified
An MPC of 0 results in a multiplier of 1 because the consumer is saving all additional income with no iteration of spending, hence no multiplier effect. An MPC of 1 results in an infinite multiplier because the consumer is spending all additional income, thus staying in the iteration.

Step by step solution

01

Understanding MPC & Multiplier Effect

The Marginal Propensity to Consume (MPC) is a measure of how much of an increase in income a consumer will spend. The Multiplier Effect is the magnification effect of initial spending changes to the overall economy.
02

Implication of MPC equal to 0

When MPC equals 0, it means that none of the income generated is being spent, rather it is being saved. Thus, there's no 'rounds' of spending, leading to no multiplier effect. This indicates no ripple effect in the economy, and thus, the multiplier is 1.
03

Implication of MPC equal to 1

On the other hand, when MPC equals 1, it indicates that the consumer spends all their additional income, leaving nothing for savings. This constant spending leads to continuous rounds of spending in the economy, and thus, creates an infinite multiplier effect.
04

Explanation through Multiplier Process Logic

The Multiplier Process suggests that an increase in autonomous expenditures leads to a larger increase in real GDP. This is due to the spending received by one household being seen as income and spent by another household, and so on. If all of it (MPC=1) or none of it (MPC=0) is spent, it leads to an infinite or no iteration.

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Most popular questions from this chapter

A column in the New York Times in 2017 noted that Tesla was expanding both its California automobile factory, where it was beginning to produce its Model 3 electric cars, and its Nevada “Gigafactory," where it was producing lithium- ion batteries for cars and other uses. The article quoted an investment analyst as saying, "I don't know what kind of multiplier you put on that, but it's a significant boost to the economy." a. What does the analyst mean by a multiplier? b. Why would Tesla's engaging in this investment spending result in a significant boost to the economy? c. Why might the analyst have been unsure of the size of the multiplier in this case?

A study by the management consulting company McKinsey \& Company recommended that the federal government increase spending on infrastructure, such as bridges and highways, by between \(\$ 150\) and \(\$ 180\) billion per year. The study estimated that the result would be an increase in GDP of between \(\$ 270\) billion and \(\$ 320\) billion per year. What is the implied value of the multiplier if the McKinsey study's estimate of the effect of infrastructure spending on GDP is correct?

A Federal Reserve publication noted that "the shedding of unwanted inventories often accounts for a large portion of the decline in gross domestic product (GDP) during economic recessions." What does the author mean be "shedding of unwanted inventories"? What makes the inventories unwanted? Why would shedding inventories lead to a decline in GDP?

(Related to the Don't Let This Happen to You on page 800) Briefly explain whether you agree with the following argument: "The equilibrium level of GDP is determined by the level of aggregate expenditure. Therefore, GDP will decline only if households decide to spend less on goods and services."

An article on bloomberg.com about the Japanese economy noted, "Whether the 2.4 percent annualized gain in gross domestic product reported Wednesday can be maintained depends on consumers stepping in to buy the products that companies are piling up in warehouses." a. Did business inventories in Japan increase or decrease during this period? Briefly explain. b. What would happen if consumers do not buy the products that companies are piling up? Illustrate your answer with a \(45^{\circ}\) -line diagram.
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