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The Multiplier and the Great Depression
The concept of the multiplier was originally de- The table shows what happened to investment The numbers in the table suggest that at the
vised by economists trying to understand the spending, consumer spending, and GDP during time of the Great Depression, the multiplier was
greatest economic disaster in history, the col- those four terrible years. All data are in 2005 dol- around 3. Most current estimates put the size of
lapse of output and employment from 1929 to lars. What we see is that investment spending the multiplier considerably lower—but there’s a
1933, which began the Great Depression. Most imploded, falling by more than 80%. But con- reason for that change. In 1929, government in
economists believe that the slump from 1929 to sumer spending also fell drastically and actually the United States was very small by modern
1933 was driven by a collapse in investment accounted for more of the fall in real GDP. (The standards: taxes were low and major govern-
spending. But as the economy shrank, con- total fall in real GDP was larger than the com- ment programs like Social Security and
sumer spending also fell sharply, multiplying the bined fall in consumer and investment spending, Medicare had not yet come into being. In the
effect on real GDP. mainly because of technical accounting issues.) modern U.S. economy, taxes are much higher,
and so is government spending. Why does this
matter? Because taxes and some government
Investment Spending, Consumer Spending, and Real GDP in the Great Depression programs act as automatic stabilizers, reducing
(billions of 2005 dollars) the size of the multiplier. For example, when in-
comes are relatively high, tax payments are rel-
1929 1933 Change
atively high as well, thus moderating increases
Investment spending $101.7 $18.9 −$82.8
in expenditures. And when incomes are rela-
Consumer spending 736.6 601.1 −135.5 tively low, the unemployment insurance pro-
Real GDP 977.0 716.4 −260.6 gram pays more money out to individuals, thus
Source: Bureau of Economic Analysis. boosting expenditures higher than they would
otherwise be.

Consumer Spending

Should you splurge on a restaurant meal or save money by eating at home? Should you
buy a new car and, if so, how expensive a model? Should you redo that bathroom or live
with it for another year? In the real world, households are constantly confronted with
such choices—not just about the consumption mix but also about how much to spend
in total. These choices, in turn, have a powerful effect on the economy: consumer
spending normally accounts for two -thirds of total spending on final goods and serv-
ices. But what determines how much consumers spend?

Current Disposable Income and Consumer Spending
The most important factor affecting a family’s consumer spending is its current dis-
posable income—income after taxes are paid and government transfers are received. It’s
obvious from daily life that people with high disposable incomes on average drive more
expensive cars, live in more expensive houses, and spend more on meals and clothing
than people with lower disposable incomes. And the relationship between current dis-
posable income and spending is clear in the data.
The Bureau of Labor Statistics (BLS) collects annual data on family income and
spending. Families are grouped by levels of before-tax income; after-tax income for
each group is also reported. Since the income figures include transfers from the gov-
ernment, what the BLS calls a household’s after-tax income is equivalent to its current
disposable income.
Figure 16.1 on the next page is a scatter diagram illustrating the relationship be-
tween household current disposable income and household consumer spending for

module 16 Income and Expenditure 161