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Experiment 5 The multiplier process

5.1 Introduction

CORE projects

Concepts in the experiment are related to the material in:

How does an individual’s choice of consumption affect the consumption, employment, production, and income of others? How can aggregate demand be derived from the interaction of many consumption choices? Why is there inertia in the reaction to a shock, for example, an increase in the overall level of investment? Why is the increase in production larger than the initial shock?

The aim of this experiment is to let students experience the interdependence of demand choices. The positive feedback between choices allows for an understanding of the multiplier process, aggregate demand, and the business cycle. Students should gain this experience before they have been formally introduced to the model of the multiplier. It is important to run the experiment ahead of students reading Unit 14—otherwise they will ‘solve the model’ by calculating the multiplier and fail to ‘experience’ the interdependence in decisions that lie behind it. Ideally, it would take place at the end of the session on Unit 13.

The experiment in this chapter is a variant of a beauty contest game, and puts participants in the role of households in an economy. They have to choose their level of consumption. The aim is to set consumption as close as possible to 80% of income. Consumption and a fixed level of investment spending generate production and income. So, participants do not know the level of income when deciding on consumption, as this is created by the simultaneous consumption decisions of everyone in the economy.

Experimental evidence shows that students slowly converge to the equilibrium value that results from the multiplier process. This is in line with the so-called Robertson lag, in other words, that consumption is chosen as a best response to lagged income. Students experience that excess savings (more than 20% of their income) can result from their choice of too little consumption or from excess consumption by others, resulting in high income. They also experience insufficient savings (less than 20% of their income) as a consequence of excessive consumption or low incomes due to low consumption by others. Students experience the interdependence of income and consumption and learn about the endogenous nature of income in a macroeconomy.

You may find it useful to read about the experiences of instructors before getting into the detail of setting up the experiment, especially if you are new to running classroom experiments.

The experiment is based on Johann Graf Lambsdorff and Marcus Giamattei. 2022. Macroeconomics. Lecture in Economics.

Citation

Giamattei, Marcus, Johann Graf Lambsdorff and Humberto Llavador (2022). ‘The multiplier process’. Experiment 5 in The CORE Team, Experiencing Economics. Available at https://www.core-econ.org/experiencing-economics [Accessed on (date)].

Key concepts

This experiment will help students understand the following key concepts:

  • Keynesian Multiplier
  • Multiplier model
  • Aggregate demand
  • Savings and Investment
  • Consumption

5.2 Requirements

Timing

The standard variant of the game consists of 10 rounds of decisions. It can be run in 30 minutes (including some introductory explanation). Remember to allow time for a stimulating discussion.

5.3 Description of the experiment

In this experiment, students are all grouped together in one economy. Each student represents one household deciding on the level of consumption over ten rounds. The goal is to set consumption close to 80% of the household’s income. This means that households want to have a consumption rate of 80% and a savings rate of 20%. The chosen level of consumption is then produced by a central producer together with a fixed level of investment goods. This generates household income, which is determined by the average of all consumption decisions + investment. The investment spending in the economy by firms and government combined is exogenous and is 100 per household in the first five rounds. In Round 6, investment is increased to 200 for the remainder of the game.

5.4 Step-by-step guide

Detailed instructions

Go to the ‘Quick summary’ section if you have previously run the experiment and just need a brief reminder of the instructions.

5.5 Student instructions

These are also available in the students’ version.

A PDF of the student instructions and homework questions is also available.

Each participant in this experiment represents one household in an economy. In each of the 10 rounds, your only task is to determine the level of consumption for your household. At the same time, the other participants determine the levels of consumption for their households.

Production is organized by Linda, a central producer whose behaviour is determined by the computer.

Linda collects information on the level of consumption by all households and sets the level of production according to aggregate demand. Aggregate demand consists of all households’ level of consumption plus aggregate investment. Aggregate investment is produced by Linda, amounting to 100 per household.

Each household works an identical amount to produce aggregate demand and achieves an income by selling its labour to Linda. Linda sells her produced goods to the households according to their level of consumption.

While deciding on consumption you do not know your household’s income. The total economy’s income depends on Linda’s production and, thus, aggregate demand. This in turn is determined by all households’ consumption, plus investment. Each household gets an equal share of total income. As a consequence, for each household, income is given by

\[\text{INCOME } = \text{ AVERAGE CONSUMPTION } + 100\]

You should aim to set consumption for your household close to a target. This target is a share of your household’s income and the remaining share is saved. The target for consumption is: TARGET = 0.8 × INCOME. The participant whose consumption comes closest to the target over all rounds is declared the winner.

5.6 Predictions

Predicted results

At the end of the experiment, you will see the results in the line chart. You can expect to obtain something similar to the graph in Figure 5.6, which shows the results from the reference example in classEx: an experiment run with 21 students at the University of Passau (Germany) in 2022.

5.7 Discussion

A good discussion following the experiment is important. Ask your students the following questions to frame the discussion.

Interpreting the graphs

Comments under ‘What might go differently?’ in Section 5.6 Predictions above provide useful further information.

5.8 Homework questions

Registered instructors can access answers to question 5.

These questions can be set for students to work on outside the classroom or can be completed and discussed in the classroom. They may help students reflect on their experience and understand their and others’ behaviour in the experiment.

Please note that the questions are based on the standard parameters.

For question 1, you have to share a screenshot of the results screen with your students. If your results screen does not show the predicted results, you can use Figure 5.6 and share it with the students.

For question 2, you have to share data from the experiment in Round 1. Data from your experiment can be downloaded as an Excel file from the ‘data’ menu on the instructor’s screen in classEx. You can use this data to create your own questions. A description of the data variables can be found in the ‘Downloading the data from your experiment’ section.

The following text is also available in the students’ version.

  1. Your instructor shared with you the results of the game that you played.
    1. Determine the equilibrium level of consumption and income if investments are fixed to 100.
    2. Explain the development of consumption over time and give reasons for the slow adjustment.
  2. Your instructor shared with you the consumption data from the experiment. Take the five highest and the five lowest consumption choices from the first round. Calculate their level of savings. What can you conclude about the overall level of savings?
  3. Read Section 14.2 in The Economy 1.0 and draw Figure 14.2 for the values of the game played in class. What can you conclude about autonomous consumption?
  4. Consumption is C = c0 + c1 × Y and Y = C + I. Solve the system for the equilibrium values of C, S, and Y. What can you conclude if the consumption rate c1 is equal to 0? What happens if the consumption rate is 1?

  5. A model answer for this exercise is available for download on the CORE Econ website.For this exercise you will need the Multiplier Model Excel Simulator. Assume that in this economy, net exports are zero and taxes are levied as a proportion of income.

    We are going to start by using the Excel Simulator to consider the effect of a 100% increase in investment when the marginal propensity to consume (MPC) is 0.5.

    1. Figure 1 in the Simulator shows the standard multiplier model from Section 14.2. Label the initial goods market equilibrium (GME) with an A and the new GME with a Z. Explain what it means when the economy is in goods market equilibrium.
    2. How does Figure 2 relate to Figure 1? (Hint: look at the labels on the axes)
    3. Now label the initial GME on Figure 2 with an A and the new GME with a Z.

    Figure 3 shows a breakdown of the changes happening to investment, income-dependent consumption, and output (income) over time or in each ‘spending round’.

    1. Write down the aggregate demand equation for this economy. Identify investment and income-dependent consumption in the equation.
    2. Recall the definition of MPC. Explain what it means when the MPC is 0.5.
    3. The first change in income-dependent consumption happens in spending Round 2 and has a value of 5. Explain why. (Hint: you might find it helpful to look at the aggregate demand equation you wrote down for question d.)
    4. What is the value of the next change in income-dependent consumption? Explain why.
    5. What is the link between the changes in Y, investment, and income-dependent consumption?
    6. Now sketch what a line showing the changes in aggregate demand would look like on Figure 3. (Hint: Think carefully about the timing and the GME.)

    Now let’s look at the importance of the MPC.

    1. Change the MPC value firstly to 0.2, then to 0.8. Describe and explain the changes to all three figures in each case.

    Economists use models like this to make projections or forecasts of how changes to components of aggregate demand will affect GDP.

    1. Imagine the UK economy is in recession and that the government is uncertain about the proportion of credit-constrained households, so estimates a range for the marginal propensity to consume from 0.5 to 0.65. What is the forecast range for the change in GDP, in percent, due to a 5% rise in investment as a consequence of some favourable government policies?
    2. In the Simulator, we used a single number to represent the MPC of the entire population, but in reality, the MPC may differ between individuals. Suggest some reasons why people might have different marginal propensities to consume. In your answer, propose four households of different ages, employment status (such as employed, unemployed, retired), and home ownership status (such as renter, home owner with no mortgage, home owner with a mortgage) and explain why you think the MPC would vary across these households.
    3. Use your results in k. and l. to comment on the relationship between a recession, credit constraints, household characteristics, the MPC, and the effectiveness of government policy.

5.9 Further reading

Also available in the students’ version. You may assign Section 18.2 from The Economy 1.0 if you play the variant of the game.

  • CORE. The Economy 1.0, Sections 14.1 and 14.2
  • Marcus Giamattei and Johan Graf Lambsdorff. 2015. ‘Balancing the Current Account: Experimental Evidence on Underconsumption’. Experimental Economics 18 (4): pp. 670–696.

5.10 Instructor experience

In this section we hear from instructors about their experience of running the experiment with their students.