Gross Private Domestic Investment Spending: Multipliers and Growth in the Real GDP

This Activity Exercise is appropriate for Principles of Macroeconomics, has no class size limitations, and is designed for completion in one 50 minute class period. The preparatory work can also be captured and evaluated by the instructor. It is the fifth in a sequence of five AEs designed by the author to explore basic macroeconomic principles and their measurement. The five Activity Exercises are: Unemployment Rate (1), Consumer Sentiment (2), Gross Private Domestic Investment Spending (3), Housing Starts Leading Indicator (4), and Investment Spending Multipliers (5).

Overview

The Activity Exercise Gross Private Domestic Investment Spending: Multipliers and Growth in the Real GDP can be used to establish the significance of the Multiplier for the expansion of real GDP. Ideally, preparation for the Activity Exercise will raise questions about our ability to accurately measure Multipliers, as well as the efficacy of whether theoretical principles and concepts are definitive in an applied context. The Activity Exercise asks students to apply their understanding of the Multiplier to the general macroeconomic level of a quarter to quarter change in the level of real GDP.

Expected Student Learning Outcomes

At the completion of this Activity Exercise, students will be able to describe the role of Investment Spending Multipliers in the growth of Real GDP.

Information Given to Students

A year from now you are interning at Bloomberg, LP in NYC (www.bloomberg.com), a leading firm for business and financial information, news, and analysis. It's 8:30 am EST, and everyone in the office is sipping coffee while staring at video monitors or their phones. The BEA (Bureau of Economic Analysis) is about to release its first estimates for Real GDP for the most recent quarter. At 8:31 am everyone cheers because the initial BEA estimates show that Gross Private Domestic Investment increased by $80 billion from quarter to quarter, and that the overall Real GDP increased by $240 billion. The Director of the office exclaims, "That's a pretty decent Multiplier!" Your new BFF (Best Friend Forever), another intern, whispers in your ear, "What's a Multiplier?" You respond,

A. "The Multiplier is $720 billion."
B. "The Multiplier is an abstract theoretical concept found in macroeconomic principles textbooks. You can't pin a specific number on it, with any precision or certainty."
C. "Pfffft. There's no such thing as a Multiplier!"
D. "It's 3, because every dollar of new Gross Private Domestic Investment spending last quarter resulted in three dollars of new Real GDP."

Gross Private Domestic Investment Spending: Multipliers and Growth in the Real GDP (Microsoft Word 2007 (.docx) 143kB Jul16 18)

Instructor should lead students through a post Activity Exercise discussion on the calculation, use and meaning of the Multiplier Effect.

D. is the correct answer (for those of us who acknowledge the Keynesian Multiplier).

A. Would triple the increase in the Real GDP.

B. Is a reasonable response, and you might consider giving some credit for this answer.

C. Is incorrect for those of us who acknowledge the validity of Multiplier effects from Investment and Government spending in Macroeconomics.

Suggested Debriefing Discussion Questions:

Why is Gross Private Domestic Investment spending so important for the growth
of Real GDP?
What is meant by capital formation?
Is it important to quantify the Multiplier? Why or why not?
If not, does that make the Multiplier a viable theoretical explanation for how
spending for new capital stimulates growth in the GDP?

Students should be able to articulate the theoretical reasoning for the Multiplier. Students should also be circumspect in our ability to precisely measure and capture macroeconomic change in the aggregate economy. The solution students will select for the AE, is thus not definitive. Instructor evaluation can be formulated through formal examination questions, presentation or discussion of challenges to our ability to measure macroeconomic change with confidence and precision.

Read the Kahn Academy article: "Positive Externalities of Innovation"

Watch the Kahn Academy video "What is Capital?"

Watch the Tutor2U Video "Multiplier Effect"