4.2 The Multiplier - Limitations of the Multiplier Effect Flashcards
(5 cards)
List the four limitations of the multiplier effect.
- Size of the multiplier, k
- Level of spare capacity in the economy
- Time lags
- Difficulties in measurement
How does the size of the multiplier k limit its effect?
If the MPC is very small, the size of k would in turn be very small. For a given injection, a large part of the gain in income will be withdrawn and very little will be spend and very little income will be circulated back into the economy to generate expenditure and income at subsequent rounds. Overall the increase in RNY will be dampened.
How does the level of spare capacity in the economy limit the economy?
If the economy is moving closer to full employment along the intermediate range of the AS curve ==> supply bottlenecks emerge ==> firms are forced to rely on less efficient resources ==> increasingly difficult to expand output.
Rise in prices makes production more profitable ==> firms are incentivised to increase output despite the constraints ==> firms respond to the rise in demand by partially raising prices and partially increasing output.
Increase in GPL dampens the multiplier effect as it reduces the level of consumption b households ==> fal in level of AD.
How do time lags limit the multiplier effect?
It takes time for the multiplier effect to work and only a fraction of the multiplier effect will be observed quickly.
How do the difficulties in measurement limit the multiplier effect?
It is difficult to precisely measure the MPM, MPS, and MPT making the estimation of the size of the multiplier difficult.
