The multiplier and accelerator effect key terms. Match the key terms with the correct definition in the table below.

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1 The multiplier and accelerator effect key terms Match the key terms with the correct definition in the table below. Accelerator Effect Multiplier Effect Marginal rate of tax Planned Investment Propensity to import Propensity to save Space capacity. The rate of tax on the next unit of earned income. The proportion of any change in income that is saved rather than spent. The proportion of any change in income that is spent on overseas products. When spare capacity is high aggregate supply is elastic. Capital Investment is linked positively to growth of consumer demand. Planned spending by businesses on new capital goods. Initial injection of demand leads to bigger final rise in equilibrium GDP

2 Accelerator Revision Worksheet The Accelerator The accelerator model is closely linked to the multiplier. The model looks at the relationship between a rise in national income in an economy and the effect upon capital investment by firms. Planned capital investment by firms is linked to the growth in demand for goods and services. Thus when there is an injection into the circular flow the multiplier effect will cause consumers to demand a higher number of goods and services. To meet this increase in demand firms need to increase their capacity and thus capital investment takes place. This is known as induced investment. This is the accelerator effect. The larger the value of the multiplier (the bigger the marginal propensity to consume) the greater the accelerator effect upon the economy. The increase in consumer demand means that firms are more willing to borrow to purchase capital goods and thus AD will shift to the right. The model also works in reverse, falling demand, leads to falling demand by firms for capital goods. Question Bank 1) What is the role of changed investment in explaining the accelerator effect? (5 marks) 2) Using examples, explain the difference between the multiplier and accelerator. (10 marks)

Accelerator case study The slump in demand for new cars will have a reverse accelerator effect with car firms slashing their capital investment plans.

3 Accelerator case study The slump in demand for new cars will have a reverse accelerator effect with car firms slashing their capital investment plans. An article on the BBC website today, February 20th, highlights that car production in January was 58.7% lower than in January A UK car plant that directly and indirectly employs more than 6,000 people may be forced to close within days, a trade union leader has warned. Unite joint leader Tony Woodley refused to name the facility in question, but said it needed urgent state aid to stay open. Business secretary Lord Mandelson declined to comment, but urged people to "stop feeding the rumours". The comments came after data showed UK car production slumped in January. "We've got a car plant that, within just a couple of days, would have run out of cash and needs serious financial help to stop over 6,000 people losing their jobs," said Mr Woodley. He said the government had to act to prevent "a catastrophe". Lord Mandelson said: "Rumours can very easily turn into a shockwave that destabilises a company or an industry and brings about the very outcome that we are seeking to avoid." He added that the government would help if it could. Falling demand New car production in the UK fell dramatically in January from a year earlier, according to the Society of Motor Manufacturers and Traders (SMMT). A total of 61,404 new cars were produced last month, 58.7% lower than January 2008, as plants closed for extended winter shutdowns. Car firms have been hit by falling demand amid a wider economic slowdown. The SMMT said that the decline in vehicle output highlighted the need for more measures to help the industry. SMMT chief executive Paul Everitt said that production for overseas markets, particularly Europe, had weathered the downturn better than production for the domestic market. "European markets have been lifted by scrappage incentive schemes," he said. "SMMT continues its call for a UK plan to boost the new vehicle market and support employment throughout the sector," he added. A total of 51,272 new cars were made for export in January, down 54.2% a year earlier. Domestic car production fell 72.3% to 10,132 vehicles. Cutting workforces Several car firms have had to cut jobs and reduce workers' hours in response to slowing demand. Ford has said up to 850 UK workers at the firm would be offered voluntary redundancy packages. BMW has said it will cut its Mini workforce at Cowley, Oxford, by 850, while 1,200 jobs are going at Nissan's plant in Sunderland. Aston Martin is axing 600 jobs at Gaydon in Warwickshire. Jaguar Land Rover, Bentley and Toyota, which has just announced a pay freeze for staff, have all announced either job cuts or production reductions. Workers at Vauxhall's UK plants also fear redundancies could be made following an announcement by the company's US parent General Motors that it is to axe up to 47,000 workers worldwide.

4 Multiplier Revision Worksheet This concept relates directly to the circular flow of income. The national income multiplier considers how an increase in injections into the circular flow will change the level of national income in the economy. To recap- Injections: Investment (I), Government Spending (G) and Exports (X) Withdrawals: Saving (S), Taxation(T) and Imports (M) If there is an injection into the circular flow the increase in national income will depend upon the level of withdrawals in that economy. Marginal Propensity The concept of marginal propensity considers the proportion of an increase in consumer s income that will be spent on the variable under consideration. For example the marginal propensity to consume (mpc) measures the increase in personal consumption following an increase in income. E.g if the mpc is 0.6 this implies that if the individual receives an extra 1 of income they will spend 60p. Marginal propensity can also be applied to saving, tax and imports. Calculating the Multiplier The multiplier can be calculated in the following way: 1/1-mpc Which is equivalent to: 1/mps + mpt + mpm Remember that mpc +mps + mpt + mpm = 1 Therefore the smaller the value of the withdrawals (and the larger the value of the mpc) the larger the value of the multiplier. 6bn is due to be spent by the UK government in order to prepare London for the 2012 Olympics. This will bring a significant multiplier effect upon the UK Economy.

5 Example 1 Assume that the mpc = 0.7 Therefore change to national income following 6bn injection- 6bn * 1/(1 0.7) = 19.9bn Example 2 Assume that the mpc = 0.3 Therefore change to national income following 6bn injection- 6bn * 1/(1 0.3) = 8.6bn Multiplier Question Bank 1) Calculate the multiplier for an economy where the marginal propensity to consume is 0.65.(2 marks) 2) By how much will national income increase if there is an injection of 100,000 (use the value of the multiplier calculated in Q1) 3) An economy has a mpc of 0.45, calculate the amount of injections that would be needed to increase national income by 20,000,000 Short Answers [10 Marks] 1) A company builds a new production unit in a certain country. Explain how this investment is likely to have a multiplier effect, and discuss reasons why this might take time to work. (10 marks) 2) International comparisons of multiplier values reveal significant variations between countries. One estimate suggested that the multiplier values were 1.42 for the UK, 1.13 for Germany and 1.76 for Japan. Explain why the multiplier may vary between countries (10 marks) 3) Explain how a change in the rate of income tax is likely to affect the size of the national income multiplier (10 marks) 4) Explain why a decrease in the marginal rate of taxation is likely to lead to an increase in the size of the multiplier (10 Marks)

OCR Economics A-level

OCR Economics A-level Macroeconomics Topic 2: Aggregate Demand and Aggregate Supply 2.1 Circular flow of income Notes The circular flow of income Firms and households interact and exchange resources in