Post on 13-Dec-2015
Business Cycle, Short Run Growth,The Multiplier & Accelerator Effects
Draw & Label this diagram with what you recall from AS Economics
Objectives
• Understand the concept of the ‘output gap’• Be able to explain how the relationship
between the ‘output gap’ and short term and long term economic growth
• Be able to explain the economic theory behind multiplier and accelerator effects
• To be confident in calculating multiplier effect
The Output Gap
• The difference between actual GDP and it’s trend value
• In other words the actual level of output minus the potential level
• Negative = trough• Positive = peak
Growth and the Output GapTop pane: Real GDP Bottom Pane: Output Gap measured as a % of potential GDP source: OECD
UK Real GDP and Output Gap
Source: Reuters EcoWin
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
07 08 09 10 11 12 13 14
-5
-4
-3
-2
-1
0
1
2
3
4
Pe
rce
nta
ge
of
po
ten
tial G
DP
-5
-4
-3
-2
-1
0
1
2
3
4
tho
usa
nd
bill
ion
s
1.39
1.41
1.43
1.45
1.47
1.49
at
con
sta
nt
pric
es
(th
ou
san
d b
illio
ns)
1.39
1.41
1.43
1.45
1.47
1.49
Annual percentage change in GDP measured at constant prices
The Cycle: Growth in UK National Output
Source: UK Statistics Commission
80 85 90 95 00 05 10 15 20
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
Pe
rce
nt
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0New normal growth rate likely to be slow .............
A permanent loss of outputUK GDP, £ billion, quarterly data measured at constant 2003 prices
Has the recession caused lasting damage?
Source: Reuters EcoWin
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
bill
ion
s
290
300
310
320
330
340
350
360
370
GB
P (
bill
ion
s)
290
300
310
320
330
340
350
360
370
UK GDP still well below the peak before the last recession..............
Trend growth is falling – why?Source: OECD World Economic Outlook
UK - Potential GDP and Trend Growth
Source: OECD World Economic Outlook
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
tho
usa
nd
bill
ion
s
1.15
1.25
1.35
1.45
1.55
Re
al G
DP
£ (
tho
usa
nd
bill
ion
s)
1.15
1.25
1.35
1.45
1.55
Potential GDP
0.00
1.00
2.00
3.00
4.00
Pe
r ce
nt
pe
r ye
ar
0.00
1.00
2.00
3.00
4.00
Estimated UK Trend Growth Rate
Recession may have inflicted damage on trend growth
AD/AS & Short Run Growth
AD & AS through a business cycle
• Multiplier Effect : “the ratio of a change in equilibrium real income to the autonomous change that brought it about ; it is calculated as 1/mpw (marginal propensity to withdraw)”
• In other words when workers see their income increase, it is the proportion of the increase that is spent and therefore benefits the economy
• Marginal Propensity withdraw : “the sum of marginal propensities to save, tax, import – the proportion of additional income that is withdrawn from the circular flow”
Worked example of multiplier
• Households save 5%• Households spend 10% of imports• Households are taxed 25%• MPW = s+m+t = ?• Multiplier effect = 1/mpw = ?
The larger the multiplier, the bigger the AD shift
Work out this example
• Households save 10%• Households import 15%• Households tax 30%• What is the marginal propensity to withdraw?• What is the multiplier effect?
The accelerator effect
• “a theory by which the level of investment depends upon the change in real output”
• As economic growth increases in recovery, firms invest more. As the cyclical growth slows, firms reduce investment
• Works in tandem with multiplier.• Firms invest, increases income of workers who
spend some in the economy, leads to growth, leads to further investment