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The Autonomous Spending Multiplier
The destruction created by Katrina gave rise to a wave of spending to rebuild homes and businesses. In this presentation, you will learn that any wave of spending creates a "snow ball" effect via additional changes in consumption that are induced by increases in income. Assume that the economy starts at equilibrium, and consumers and firms spend an extra 100 in construction materials and equipment to rebuild after the hurricane. The manufacturers of construction materials and equipment see an unexpected increase in sales, their inventories drop below the desired level and they react by increasing production. This increase in production requires and increase in employment or in hours worked or both. Thus reducing unemployment and increasing national income. Individuals who make now more money or who now have a job they did not have before, spend part of this income purchasing goods and services -TV sets, cars, furniture,etc.-. Manufacturers of these consumer goods see inventories decrease, and they too increase production and hire more workers or more hours, generating another round of increases in income, consumption and spending.
We can write this process in equation form as follows:
The original wave of spending, an increase in autonomous spending (triggered by other factor different from income): We will use a triangle to represent the "change in" and recall "a" stands for autonomous consumption (the intercept value of the consumption function). so we write the original spending wave as: Da =100
In step one, the original change in autonomous consumption is 100. This means that consumers purchased construction materials and equipment worth 100. These sales, become income (as profits to owners, wages to workers, rents to landlords and interest to financial institutions). the next step is the $100 increase in income resulting...
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