7.2 Changing levels of Growth: The Multiplier Process.
The circular flow model suggests that the economy would move towards a higher level of economic activity when the injection of I is greater than the leakage of S and vice versa. Keynes explained the process by which this adjustment takes place, and provides a means of measuring the change in the level of national income through the multiplier process.
The multiplier can be defined as the number of times an increase in national income exceeds the increase in aggregate demand that caused it.
The size of the multiplier is determined by the MPS and is expressed as:.
k = 1 .
MPS.
K = 1.
1 - MPC (since MPC + MPS = 1).
The total increase in income is found by multiplying k by the injection.
Clearly, the larger the MPS, the smaller will be the value of the multiplier. Because individuals save proportionaly more of their extra income, they will spend less and therefore generate less additional income. It therefore follows that the factor by which we must multiply our initial increase in aggregate demand must also be less. The reverse will also be true - the smaller the MPS, the larger the value of the multiplier.
7.3 The effects of Economic Growth.
Living Standards.
Faster economic growth results in an increase in real GDP per capita, which means that real wages can rise and households can enjoy a higher disposable income and therefore higher material standards.
Employment.
Economic growth creates jobs and a strong enough level of economic growth can help to make sure that everyone who is willing and able to work is able to find employment. Countries with a higher levels of economic growth tend to create more highly paid and highly skilled jobs.
External Stability.
If Australians spend a higher level of their disposable income on imported goods and services, this means that stronger economic growth can lead to a higher CAD, leading to a risk of external stability of the economy.