Question

1. According the aggregate expenditures model, is the multiplier effect of government purchases on GDP the same, higher or lower than the multiplier effect of planned investment on GDP?
2. "Your state legislators and governor are debating whether they should use state funds to encourage motion picture studios to shoot and produce films in your state. The governor’s office issues a report that includes the following statement: “The average budget for a movie is $70 million but our consultants estimate that this will have broader ripple effects across many industries and will boost state output by about $210 million dollars." question:Do you think the multiplier effect that the governor’s office is using is realistic? Why or why not?

Answer 1

(1)

In the Aggregate expenditure model, both government purchase (G) and investment (I) are autonomous. So, MPC remaining the same, autonomous spending multiplier will remain unchanged. As a result, the effect of an equal increase in G and increase in I will have the same increase in GDP, such that

Increase in GDP = Increase in G x Autonomous spending multiplier = Increase in I x Autonomous spending multiplier

(2)

Multiplier = Increase in output / Increase in expenditure = $210 million / $70 million = 3

If MPC = c, then

Multiplier = 1 / (1 - c)

3 = 1 / (1 - c)

3 - 3c = 1

3c = 2

c = 0.67

Since 0 < c < 1, the multiplier effect is realistic.