Economicskor
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Hi,

I am currently studying the new OCR syllabus for A2 economics but I was wondering if anybody could explain the Economic Cycle using the Multiplier-Accelerator Model? and also the Consequences of Government Debt?

Thanks.
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rjwilliams3
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We know that in an economic cycle we have booms and busts (recessions). The economy fluctuates between high output and low unemployment, and low output and high unemployment.
The multiplier effect and the accelerator effect help to increase output once we are on a positive trajectory. Imagine that we have just come out of a recession and the government decides to start spending. The multiplier effect will cause output to increase by more than the amount the government is spending (in the Keynesian story which I suppose the syllabus is trying to get you to talk about). This is because the government may spend £100 on building a new road, and when it does so some of that money will go towards the wages of workers who may spend it on Christmas presents for their children, let us say all £100 went to workers in the form of wages and then workers decide to spend £80 on presents (saving the other £20); the economy has now been boosted by £100+£80 = £180. But the £80 spent on presents goes to shopkeepers who may decide to build bigger shops, creating further boosts to the economy.
Thus the initial £100 of government spending had a multiplier effect which boosted the economy and got us out of the recession.
The accelerator effect is similar but says that when the economy is doing well (and is expected to do well in the future) that investment increases because firms want to expand to make sure they can cope with higher future demand (by building bigger factories for example), this all boosts output and GDP and thus accelerates the cycle. It is also self-fulfilling because higher spending on investment by firms creates more demand for other firms and that thus leads to more demand (as initially anticipated).

These effects work in reverse: when the economy has a blip and future demand looks like it will fall then firms may decide not to invest, which reduces demand and leads to a recession.

Obviously this is a simplified story and you might want to think more about the individual stages and how many firms have to be involved for these effects to occur.

For the consequences of government debt you might want to read about Ricardian Equivalence (http://learneconomicsonline.com/blog/?p=624) and the Expansionary Fiscal Contraction Hypothesis (http://learneconomicsonline.com/blog/?p=470).

Hope this helps,
Rhys
www.learneconomicsonline.com
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