We've now explored equilibrium in the goods market. We've seen that equilibrium exists whenever the level of output is equal to total spending. Now in this section we'll take a closer look at changes in this equilibrium level of output. From our equilibrium equation, we identified two factors that could influence total spending and change this equilibrium. Autonomous spending could do it through either a change in autonomous consumption or investment spending and a change in our marginal propensity to consume could also have this effect. We'll start with a quick look at what happens when there's an increase in just one of these autonomous variables, investment spending. Now this causes the aggregate spending curve to shift upwards and a new equilibrium position is established at point E1, where the new equilibrium level of output Y1. The important thing to notice here is that the increase in investment spending brings about a much larger increase in output and income. If the increase in investment spending is a hundred million rand, the increase in output and income will be considerably more than that. This is the work of the multiplier effect and amazing force that can generate huge income from just a modest injection of funds. We're going to see if the circular flow model can help shed some light on this magic. We'll start off by assuming that a company has decided to build a new factory for a hundred million rand. Investment spending and total spending in the economy rises by a hundred million rand. The business employs various factors of production to build the factory and since these factors are owned by households their income increases by a hundred million rand. And that investment was an injection into the economy, increasing the level of output and income. But that's not the end of it and this is where the mysterious multiplier kicks in. As household income rises households tend to increase their consumption spending, some new clothes, plasma TV, a meal out and so on. Now how much they increase their consumption spending by depends on their marginal propensity to consume. We're going to assume that it's 0.8, so consumption spending grows by 80 million rand, 80% of the initial 100 million rand injection. What happens to the rest of their income, the other 20 million rand? Well, what's not spent is usually saved, so savings increased by 20 million rand. This brings us to the conservative sister of that rash marginal propensity to consume, the marginal propensity to save. In this case it's 0.2. From every one-round rise in income households will save 20 cents. So while investment is seen as an injection into the circular flow of income, savings represent a leakage from the circular flow. Getting back to consumption though, as households increase their spending, the rise in demand prompts firms to increase production by the same amount, 80 million rand, which becomes another 80 million rand increase in income for the households employed by those firms. Okay, hold on, what's happened so far? Well, at this point, the 100 million rand increase in investment spending has caused total spending to rise by 180 million rand. We have the new 100 million rand factory, the building of which generated a 100 million rand of additional income for the households involved in building it. They in turn went out and spent 80 million rand of that. Now this please the firms in the economy demands up again and they duly increase production by a further 80 million rand. Okay, so what next? Well, this last increase in production means a rise in income. Households earn another 80 million rand and they're going to spend it. Well, not all of it, 80% of it. So consumption spending increases by 64 million rand. The remaining 20% the 16 million rand goes into savings. Now, back to those firms who've just picked up 64 million rands worth of sales, so good sign demands still rising. They increase production to keep up with demand and in doing so generate income of 64 million rand for their owners and employees. Once again, these households rush out and spend most of it, 80% in fact, so consumption spending rises again by 51.2 million rand. The other 12.8 million rand went into savings. Firms must again try to keep up with demand and they increase output by 51.2 million rand and generating income for their employees and owners. And so it continues. This is the multiplier effect. This round after round of further consumption spending is the indirect result of one initial increase in investment spending. So does this multiplier effect continue indefinitely? The answer, unfortunately, is no. The reason is that the induced spending, that is the changing consumption spending caused by an increase in income, is getting smaller and smaller with each cycle because households only spend a portion of their increase in income. The rest, they save. This savings represents a leakage from our circular flow model and the leakage rate is 20%. All right, keep this image of how the multiplier works in your mind. We're going to see how it translates to our goods market diagram. An increase in autonomous spending, like that initial increase in investment, causes a parallel upward shift of the total spending curve, a shift equal to the increase in investment. The vertical intercept goes up by 100 million rand. At the original level of income, Y zero, total spending now exceeds the level of output by that much. But this investment translates into income for those involved in building it. This increase in income prompts households to increase their consumption spending. Output rises to keep up with demand. This moves up to point B. Total spending still exceeds the equilibrium level of income and output. But the gap is smaller, as indicated by the vertical distance between point B and the 45 degree line. As long as total spending exceeds the level of output, firms will keep increasing production. The income of households will keep rising and so will their consumption spending. This process will continue until a new equilibrium is reached where total spending is equal to the level of output. This occurs at point E one, with an equilibrium level of income and output Y one. Comparing point E with E one, it's clear that the increase in the equilibrium level of income and output is much greater than the initial investment. By how much the equilibrium level of income changes depends on the value of the marginal propensity to consume, small C. So it's this that determines the value of the multiplier. According to our equilibrium formula, the multiplier effect is equal to 1 divided by 1 minus C. Given a propensity to consume of 0.8, the multiplier is 1 over 1 minus 0.8, which is 1 divided by 0.2, which equals 5. For every one round increase in autonomous spending, the equilibrium level of income increases by 5 round. The change in our equilibrium level of income is therefore the multiplier times the change in investment i. In our case, a hundred million round rise in investment increases the equilibrium level of output and income by 500 million round. Now, back in our circular flow model, the impact of the multiplier can be shown like this. The increase in total spending is equal to the initial investment spend 100 million round plus the change in induced consumption spending, which in the end amounted to 400 million round. The level of production and income increased by the same amount as the change in total spending, 500 million round. But there's something else, the change in savings. If income increases by 500 million round, but consumption spending rises by only 400 million round, 80%, the remaining 100 million or 20% went into savings. The interesting thing here is that the increase in savings exactly matches the original investment spend, indicating that investment spending has created its own savings. So we've looked pretty