Consumption Multiplier

Winter 2010 Final 12:

If consumption increases by a constant share of short-run output, economic shocks cause larger output fluctuations.

See the IS Curve chapter. Multiplier effects.

In the basic set-up, consumption is a “constant fraction of potential output”. 

And this feeds into the IS curve equation to be 

However, with consumption increasing by a constant fraction of short-run output, , where  is between zero and one.

When you feed this into the output equation and solve for the IS curve equation, you get

With v-bar between zero and one, the term in front exaggerates shocks to a-bar (look up “multiplier”). Meaning shocks are more exaggerated the more consumption responds to shifts in short-run output.