4.2.2

• What's the multiplier effect in economics?

  describes how an initial injection into the circular flow of income leads to a larger final increase in national income.
• What is the formula for the multiplier?

  Multiplier = $\frac{1}{1 - MPC}$
• What does MPC stand for?

  Marginal Propensity to Consume
• How is the Marginal Propensity to Consume (MPC) calculated?

  MPC = $\frac{Change \ in \ consumption}{Change \ in \ income}$
• What does the Marginal Propensity to Save (MPS) represent?

  Proportion of additional income that is saved
• What is the relationship between MPC and MPS?

  MPC + MPS = 1
• What does the accelerator effect state?

  Growth in GDP leads to larger investment changes
• Why do firms invest more when demand is rising?

  To expand capacity for future demand
• How do the multiplier and accelerator effects interact?

  Multiplier boosts AD; accelerator boosts investment
• How do the multiplier and accelerator effects contribute to economic cycles?

  • Multiplier boosts aggregate demand through spending
  • Accelerator boosts investment, acting as an injection
  • This interaction can lead to boom and bust cycles
• Multiplier & Accelerator together

  • Initial injection into the circular flow (e.g. ↑ government spending, ↑ exports).
  • This raises AD, causing an increase in real GDP and national income.
  • The multiplier effect kicks in: higher income → higher consumption → further increases in AD.
  • As real GDP grows at a faster rate, businesses see rising demand for their goods and services.
  • The accelerator effect begins: firms increase investment to expand capacity and meet future demand.
  • Investment spending is itself an injection into the economy (via AD = C + I + G + X - M).
  • That investment leads to more income, triggering another round of the multiplier effect.
  • Result: a positive feedback loop where rising demand and output fuel more investment and spending, amplifying GDP growth.