1. How do economists think the multiplier works? 2. What is the formula for the marginal...

1. How do economists think the multiplier works?

2. What is the formula for the marginal propensity to consume?

3. What does the 45 degree line represent in the aggregate expenditures model?

Solutions

Expert Solution

1. According to economists, the multiplier works through change in income due to change in any component of spending. This happens because economists believe that one person's spending is another person's income. So, as spending increases, income also increases. For example- as the government increases its spending in the economy, it will increase the income in the country and similarly when there is a leakage from the economy, meaning that the spending is taken out, it will lead to a decrease in income. However, the size of the multiplier depends on marginal propensity to consume or marginal propensity to save.

2. Marginal propensity to consume (c) = change in consumption divided by change in income

3. 45 degree line represents the equilibrium in the economy. As on its every point, Y = AE meaning GDP (Y) equals Aggregate Expenditure (AE). Any deviation of AE line from this equilibrium line represents that economy is out of equilibrium so adjustment will take place until equilibrium is reached on the 45 degree line. This line is also called as the 'Keynesian Cross'.

Rahul Sunny answered 1 year ago

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