international finance and trade 4

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INTERNATIONAL TRADE ANDFINANCE

LECTURE NO. 4

Prof. Mazahir saifee



Multiplier

Foreign trade Multiplier



Concept of multiplier.

The concept of multiplier is derivedfrom the concept of MPC. (marginalpropensity to consume) it refers to theeffect of change in the outlay onaggregate income through induced

investment.



KEYNESIAN MULTIPLIER

EFFECTS

Lets say you find a dollar in the street. You now have one dollar you did not have before. You now have an

income of one dollar. What can youdo with that dollar?? You can spend all

of it, save all of it, or spend some of it and save some of it. You have options!




EFFECTS

Lets assume you decide to spend theWHOLE dollar. Your spending of that dollar

is an EXPENDITURE for you and INCOMEfor the person (entrepreneur) you tradedwith.




EFFECTS

How much did GDP increase with thistransaction?

$1.00

(you bought stuff)




EFFECTS

Now what happens to that dollar in thepossession of the entrepreneur? Theyhave the same options you had:

Spend it or Save it.




EFFECTS

Lets assume the entrepreneur spendsthe WHOLE dollar at another business.

This expenditure for the entrepreneur isnow INCOME for another

entrepreneur.




EFFECTS

How much did GDP increase with thistransaction?

$1.00

Does this sound familiar??




EFFECTS

This found dollar has now purchased$2.00 worth of goods and/or services.

The original dollar appears to be cloningitself!!




EFFECTS

If we repeat this pattern, it would go onFOREVER and GDP would increaseINFINITLEY. Is this possible?UnlikelyWhy?




EFFECTS

People have a TENDENCY TO SAVE someportion of each dollar they receive.

Keynes had a fancy name for this: MarginalPropensity to Save (MPS). In laymansterms this means people have a TENDENCYTO SAVE A PORTION OF EACH

ADDITIONAL DOLLAR they receive.




EFFECTS

The flip side of this is people have aTENDENCY TO SPEND (or CONSUME)

some portion of each dollar they receive.

Keynes had a fancy name for this: MarginalPropensity to Consume (MPC). Inlaymans terms this means people have aTENDENCY TO CONSUME A PORTION OFEACH ADDITIONAL DOLLAR they receive.




EFFECTS

Example: If I get an additional dollar Imay consume .90 and save .10.

My Marginal Propensity to Consume(MPC) that dollar is then: 90%.

My Marginal Propensity to Save (MPS)

that dollar is then: 10%.




EFFECTS

Example: If I get an additional dollar Imay consume .80 and save .20.

My Marginal Propensity to Consume(MPC) is then: 80%.

My Marginal Propensity to Save (MPS) is

then: 20%.




EFFECTS

Do you notice a pattern?

MPC + MPS = 1.00 (or 100%)




EFFECTS

Lets see how this works in practice.

Assume the Government wants to increase

their spending by $10 billion dollars. Assumethat the MPC in the economy is 90% and theMPS is 10% (remember these must equal100%). What is going to be the effect on the

GDP when we consider the Multiplier effect of EACH of those dollars?




EFFECTS

The Government initially spends $10billion in the economy to purchasegoods and services. Does theGovernment SAVE any of this money?NO. They spend the whole! What is

the immediate effect of this transactionon GDP? It INCREASES by $10billion.




EFFECTS

What is now going to happen to that $10 billion now in the hands of peoplein the economy? Keynes says that people in general will spend 90% of it and save 10%.

So when people spend 90% of $10billion, how much is GDP going toincrease by? $9 billion.




EFFECTS

With these initial two transactions, howmuch has GDP increase by?

$10B + 9B = 19B

Once again the original $10B has magically turned into $19B in GDP .




EFFECTS

Do you want to do all that math toarrive at how much GDP is going toincrease in the end. I did not think so.

Keynes came up with a simple formulato do the math for you. Remember in

the beginning it was GO VERNMENTthat started this buying. This is veryIMPORTANT to remember.




EFFECTS

The Keynesian Government Spending Multiplier

is 1/MPS. WOW that will be hard to remember!

Lets use the information we have already beengiven: The MPC is 90% and the MPS is 10%.

We can plug the appropriate number into theGovernment Spending Multiplier and come up with auseful number.

Govt. Spending Multiplier =1/MPS = 1/10% = 1/.10 = 10



KEYNESIAN MULTIPLIEREFFECTS

Now this is AMAZING! According to KEYNES when government spends adollar in the economy it is going to purchase a multiple of 10 times itself

in GDP.

If Government increases spending by 10 Billion, then the eventual impact on GDP is going to be an increase of:

$10 Billion X 10 = $100 Billion

NOTE: This works in REVERSE as well. If Government DECREASESspending by $10 Billion, it will serve to DECREASE GDP by a multiple of 10!



Foreign trade multiplier

The foreign trade multiplier, also knownas the export multiplier, operates likethe investment multiplier of Keynes. It

may be defined as the amount by which

the national income of a country will

raised by a unit increase in domesticinvestment in export



Working of foreign trade

multiplier Suppose, the exports of the country

increase. To begin with, the exporterswill sell their products to foreigncountries and receive more incomes. inorder to meet the foreign demand, theywill engage more factors of production

to produce more. This will raise theincome of the owners factors of production. this process will continueand national income increases by the

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