Essay on Multiplier Accelerator Effect PDF

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Multiplier Accelerator Effect...

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Part (A)  Analyse the multiplier and the accelerator effects that may occur when there is a fall/increase in one or more of the components of aggregate demand (10 marks)  Multiplier is the is  the change in equilibrium Real GDP divided by the change in autonomous expenditure, which causes Real GDP to change. K = how much the AD shifts left or right in response to a change in income or spending. Accelerator is larger percentage change investment due to a change in aggregate demand.

 The multiplier effect comes about because injections of demand into the circular flow of income stimulate further rounds of spending and this can lead to a much bigger effect on equilibrium output and employment. Furthermore, each time there is an additional rise in spending and income the multiplier is a fraction of the previous addition to the circular flow .The final increase in output and employment can be far greater than the initial injection of demand because of the inter-relationships within the circular flow.  At AD, it does not trigger inflation as the AS curve is perfectly elastic at AD to AD1 at the same price level. As seen in the left graph originally the macroeconomic equilibrium of the India was assumed to clear at EQ1, at the level of Inflation of I1, and Real National Income Y1. However, since India has the highest consumer confidence at the moment, there may be a higher marginal propensity to consume (MPC), which should result in a multiplier effect, where one shift of AD causes multiple shifts. This might result in the another shift out of the AD curve from AD1 to AD2, creating a new macroeconomics equilibrium at EQ2 with a greater level of inflation at I2.  The government of India may then further influence the size of the multiplier through changes in direct taxes, such as the cut of basic rate of income tax, which will increase the amount of extra income. This provides individuals with greater disposable income which potentially increases spending which may result in another multiplier effect. 

Since demand may be rising for goods in India due to the increase in consumer spending, firms may decide to increase their output, which serve as an accelerator as seen in the graph on the left, due to the investment demand from firms increasing from I1 to I2. Due to this shift and the impacts of the multiplier, the accelerator effect could be extended due to other firms not in the market finding it enticing to invest into, and thus entering it, further increasing output and investment demand. This process is known as the accelerator effect. But the accelerator effect can work in the other direction A slowdown in consumer demand can create excess capacity and may lead to a fall in planned investment demand.    Using suitable examples, explain the difference between the multiplier and accelerator  The multiplier effect was designed to help governments achieve full employment. This macroeconomic “demand-management approach”, designed to help overcome a shortage of business capital investment, measured the amount of government spending needed to reach a level of national income that would prevent The higher is the propensity to consume (MPC) domestically produced goods and services, the greater is the multiplier effect. The government can influence the size of the multiplier through changes in direct taxes. For example, a cut in the basic rate of income tax will increase the amount of extra income that can be spent on further goods and services. Another factor affecting the size of the multiplier effect is the propensity to purchase imports (MPM). If, out of extra income, people spend money on imports, this demand is not passed on in the form of extra spending on domestically produced output. It leaks away from the circular flow of income and spending.  Planned capital investment by private sector businesses is linked to the growth of demand for goods and services. When consumer or export demand is rising strongly, businesses may increase investment to expand their production capacity and meet the extra demand. This process is known as the accelerator effect. But the accelerator effect can work in the other direction! A slowdown in consumer demand can create excess capacity and may lead to a fall in planned investment demand. A good example of this in recent years is the telecommunications industry. Capital investment in this sector surged to record highs in the second half of the 1990s, driven by a fast pace of technological advance and huge increases in the ICT budgets of corporations, small-to-medium sized businesses, and extra capital investment by the public sector (including education and health). The telecommunications industry invested giant sums in building bigger and faster networks, but demand has recently slowed (leaving the industry with a vast amount of spare capacity - an under-utilisation of resources) – the accelerator mechanism working in reverse. ...