Multiplier effect and Accelerator Flashcards
(15 cards)
What is the multiplier effect?
A process where an initial change in aggregate demand (AD) leads to a larger final change in national income/output.
How does the multiplier effect work?
Initial spending creates income for others
They spend part of that income
That spending becomes income for more people
Cycle continues, increasing GDP by more than the original injection
Multiplier formula (basic version)?
1
1-mpc
Where MPC = Marginal Propensity to Consume
What is MPC?
The proportion of extra income that households spend on consumption.
If MPC = 0.8, then 80% of extra income is spent
What is the full multiplier formula (including leakages)?
1
mpw (mps+
mpt+mpm)
Where:
MPS = Propensity to Save
MPT = Propensity to Tax
MPM = Propensity to Import
What reduces the size of the multiplier?
High leakages (savings, taxes, imports) reduce the size of the multiplier because less income is re-spent in the economy.
What is the accelerator effect?
When an increase in national income leads to a larger increase in investment, because firms expect higher future demand.
How do the multiplier and accelerator effects interact?
Multiplier: Spending → Income → More Spending
Accelerator: Rising income → More investment → Boosts AD further
Together, they can cause rapid economic growth—or amplify downturns.
What factors reduce the size of the multiplier?
High Marginal Propensity to Save (MPS)
High Marginal Propensity to Tax (MPT)
High Marginal Propensity to Import (MPM)
These are all leakages that stop income from circulating in the domestic economy.
What happens if there is a culture of saving?
High MPS means less spending from additional income, so the multiplier is smaller.
What is the difference between the multiplier and accelerator?
Multiplier: Focuses on consumer spending and how one injection creates more income and spending.
Accelerator: Focuses on how changes in GDP growth affect investment decisions by firms.
What is the accelerator effect?
When GDP growth rises, firms expect future demand to rise, so they increase investment in capital to meet that future demand.
What happens to investment if GDP growth slows or falls?
Firms become less confident, reduce investment, and may cut back—leading to a decline in AD (reinforcing the slowdown).
How do the multiplier and accelerator interact during a boom?
Initial spending boosts GDP (multiplier)
Rising GDP boosts investment (accelerator)
Investment boosts AD further (feeding back into multiplier)
→ Can cause strong, sustained growth
How do the multiplier and accelerator interact during a downturn?
Fall in spending reduces GDP
Firms cut investment due to weak demand expectations
AD falls even more → recession deepens
