The Multiplier Effect
- This is when an initial increase in AD leads to further increases in AD.
Example
- if the government increase spending on state pension
- this is an increase in G
- AD = C + I + G + (X-M)
- so this increase in G leads to a right shift in AD
- consumers will have an increase in disposable incomes
- so this would cause an increase in C
- which would cause AD to increase further
- this could also cause further increases in consumer spending
- for example, staff at local cafes and restaurants may get more tips
- therefore they may increase their consumer spending
What does the multiplier effect depend on?
- k = 1/(1-MPC)
- k: multiplier = increase in AD/ initial increase in AD
- MPC: marginal propensity to consume - how much of an extra £1 would you spend rather than withdraw (save/ spend on imports)
Accelerator effect
- when there is an increase in economic growth
- business investment is more likely to increase
- or vice-versa
Example
- if businesses are expecting pensioners to spend more money, and
- if businesses are close to full capacity
- they will be likely to increase spending on hiring more staff or improving technology/ capital
Another example - Eat Out to Help Out
- Multiplier effect is when an initial increase in AD leads to further increases in AD.
- For example
- government spending increases e.g. Eat Out to Help Out
- scheme where government spent money to cover half of restaurant bills on certain days
- this encouraged more people to go out for food after covid
- greater consumer confidence
- greater consumer spending on food compared to before
- greater consumer spending on travel/ tfl/ fuel/ uber/ dessert/ shopping on the way home
- overall AD increased by more than the initial increase in gov spending
- k = 1/1-MPC
- k: multiplier = increase in AD/ initial increase in AD
- MPC: marginal propensity to consume - how much of an extra £1 would you spend rather than withdraw (save/ spend on imports)
- Accelerator theory: business spending is more likely to increase after an increase in consumer confidence and consumer spending
- For example
- as more people wanted to try new restaurants
- restaurants could begin to invest in top chefs and top ingredients
- as they have an expectation of demand