Lecture 11
The MULTIPLIER

1. Full-employment GDP

• Is u = 0 at full employment? Good heavens, no!
• Actual GDP vs. Potential GDP
• Actual unemployment (u) vs. natural rate of unemployment (u*)

1.1 Recessionary gap

• Actual GDP is less than Potential GDP

1.2 Inflationary gap

• Actual GDP is greater than Potential GDP
• Yikes! How is this possible?

2. Change in exogenous spending

Multiplier = Change in GDP / Change in exogenous spending

2.1 Model #1

• Exogenous variables: I, G, X-IM, T
• Suppose I increases
  • The AE-line shifts up (by how much?)
  • Eqbm GDP increases (by how much)

2.2 Computing the multiplier

Investment Multiplier = Change in Y / Change in I

2.3 More about the multiplier

• The multiplier is greater than 1 (why?)
• Multiplier = 1/(1-MPC) in the base model (Model #1)
• Suppose firms had decreased their spending. Is the multiplier any different?

3. A first look at fiscal policy

• If the economy is in a recessionary gap, what can the govt do?
  • Increase G, or
  • Decrease T
• Effect on aggregate expenditure?
• Effect on GDP and unemployment?

3.1 Questions

• Compute the government spending multiplier. Show that it equals 1/MPS in the base model (Model #1)
• Compute the tax multiplier.
• Why is the government spending multiplier greater than the tax multiplier?

4. Transfer payments

• If the govt increases transfer payments, what happens to GDP?
• Hint: Begin with the consumption line in the income-expenditure diagram

5. International trade

5.1 Changes in the exchange rate

• If the dollar depreciates, AE will increase (why?)
• Effect on eqbm GDP?

5.2 Change in foreign GDP

• How will a decrease in Canada's GDP affect the U.S. economy?
• Hint: Look at the (X-IM) component of aggregate expenditure on U.S. goods and services