OCR A Level Economics: The multiplier, the economic cycle and output gaps (H460)

This guide follows the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. It covers the topic The economic cycle, in the area of study Aggregate demand and aggregate supply, which sits in the Macroeconomics content (Component 02). The text labels none of it as AS or Extension. The countries and figures below are made up for illustration. Money is in currency units (cu).

Track progress with the OCR Economics hub, the printable checklist and the free diagnostics. Then use the revision notes and the practice questions. See also the macroeconomics overview. The circular flow, propensities and AD/AS model are separate units, used here as tools.

What this guide covers

You must be able to explain the cycle stages, distinguish actual from trend growth and evaluate what sets the trend. You must also be able to explain, determine and calculate the multiplier, link it to the circular flow and the AD curve, explain the multiplier-accelerator model, and explain output gaps with three diagrams and evaluate their causes and consequences.

1. Stages of the economic cycle

The economic cycle (business cycle) is the repeated pattern in which real GDP grows faster than usual, slows, sometimes falls, then recovers, fluctuating around its long-run trend.

On a diagram, time is on the horizontal axis and real GDP on the vertical axis. Trend is a rising line; actual output is a wave around it.

Stage	Output and growth	Typical signs
Boom (peak)	Strong growth, output above trend	Low unemployment, rising prices and wages, firms near full capacity
Downturn	Growth positive but falling	Orders slow, investment is cut, price rises ease
Recession, trough	Output falls, then bottoms out	Rising unemployment, spare capacity, low inflation
Recovery	Growth returns, output climbs back	Confidence and hiring return slowly, spare capacity remains

A common definition of a recession is a fall in real GDP for two consecutive quarters, a convention rather than a law.

2. Actual and trend rates of growth

Actual growth is the percentage change in real GDP over a period. The trend rate of growth is the long-run average rate at which the economy’s productive capacity (potential output) grows. It is the rate sustainable without building up inflation.

Worked example: actual growth and an average

Country Q (illustrative) real GDP, cu billion:

Year	1	2	3	4	5	6	7	8
Real output	400	412	428	436	425	432	450	466

Growth in year 3 = (428 - 412) / 412 x 100          = 3.88%
Growth in year 5 = (425 - 436) / 436 x 100          = -2.52%
Growth in year 8 = (466 - 450) / 450 x 100          = 3.56%
Average over 7 years = (466 / 400)^(1/7) - 1        = 2.21% a year

Year 5 is a fall in real GDP. The 2.2% average estimates the trend only if the start and end years are at similar points of the cycle, so compare peak to peak or trough to trough.

Real and nominal. Nominal GDP of 582.5 with a deflator of 125 gives real GDP of 582.5 ÷ 125 × 100 = 466. Always measure growth in real terms.

3. Factors determining the trend rate of growth

Trend growth is a shift of the long-run aggregate supply curve to the right, or an outward shift of the PPF/C. It comes from more resources or from better use of resources.

• Labour: population, migration, participation and ageing change the labour supply.
• Human capital: education, training and health raise productivity per worker.
• Capital: net investment adds to the capital stock and depends on confidence, interest rates and profits.
• Technology: new methods raise output from the same inputs.
• Natural resources: discoveries add to potential output and depletion subtracts from it.
• Institutions, infrastructure and competition: secure property rights, reliable transport and open markets let firms invest and cut costs.

If the labour force grows by 0.5% a year and output per worker by 1.8%, potential output grows by 1.005 × 1.018 - 1 = 2.31% a year.

Evaluation. Productivity is usually the main source of growth in a mature economy because the labour force grows slowly. Factors work together: skilled workers with more capital produce more than each factor alone. Education and infrastructure take years to pay off. A long recession may lower trend growth if firms stop investing and the unemployed lose skills (hysteresis).

4. The national income multiplier

The national income multiplier shows how many times larger the eventual change in national income is than the injection (or change in autonomous aggregate demand) that started it.

k = eventual change in income / starting injection

Role and purpose. The multiplier explains why a change in spending has a larger final effect on income. It lets analysts estimate how far a change in investment, government spending or exports will alter national income, and shows why small shocks can become large swings in output.

The circular flow explanation

In the circular flow, injections (investment, government spending, exports) add to income and withdrawals (saving, taxes, imports) take income out. When an injection raises income, households spend part of the extra income and withdraw the rest. The part spent becomes someone else’s income, and a share of that is spent too. The rounds shrink and the total converges. Equilibrium is where injections equal withdrawals.

Calculation

k = 1 / (1 - MPC)        where there are no taxes or imports
k = 1 / MPW              with MPW the sum of mps, mpt and mpm

Here mps, mpt and mpm are the fractions of each extra unit of income that are saved, taxed or spent on imports, and MPW is the marginal propensity to withdraw. The propensities are taught in a separate unit.

If MPC = 0.85, k = 1 / (1 - 0.85) = 6.67.

Worked example: rounds of spending

Country R (illustrative) has mps = 0.12, mpt = 0.18 and mpm = 0.20. Government spending rises by 70.

MPW = 0.12 + 0.18 + 0.20 = 0.50
k   = 1 / 0.50          = 2
Change in income = 70 x 2 = 140

Each round, 50% of extra income is re-spent at home (1 - 0.50). The extra income in rounds 1 to 5 is 70.0, 35.0, 17.5, 8.75 and 4.375, a total of 135.625. Later rounds add the remaining 4.375, giving 140.

Determinants of the size of the multiplier

• Higher mps, mpt or mpm means a smaller multiplier, because more income leaks from the domestic flow each round.
• A higher MPC at home means a larger multiplier.
• Spare capacity means the multiplier acts on output; near full capacity much of the effect is on prices.
• Confidence and credit affect whether households and firms spend or hold back.

With mpm = 0.35 instead of 0.20, MPW = 0.65 and k = 1.54. If mps rose to 0.22 instead, MPW would be 0.60 and k would be 1.67.

The multiplier and the AD curve

The multiplier shifts the AD curve to the right by the initial injection × k, measured at each price level. How much real GDP rises depends on aggregate supply.

In an illustrative economy, AD0 gives real GDP of (1,200 - 4P) and SRAS gives (400 + 4P), P being a price index. Equilibrium is P = 100, real GDP = 800. Government spending rises by 24 and k = 2.5, so AD shifts right by 24 × 2.5 = 60: AD1 is (1,260 - 4P). The new equilibrium is P = 107.5 and real GDP = 830. Real GDP rises by only 30, an effective multiplier of 30 ÷ 24 = 1.25, because prices rose.

Evaluation: the full multiplier appears only when SRAS is flat (spare capacity). Nearer full capacity, more of the shift is lost to higher prices. Crowding out, time lags and falling confidence also reduce it.

5. The multiplier-accelerator model

The accelerator links investment to how fast income is growing: net investment depends on the change in income, not its level. Firms with a capital-output ratio of v need v extra units of capital for each extra unit of output.

Net induced investment = v x change in income

Example with v = 2:

Year	1	2	3	4	5	6	7	8
Income	500	520	545	565	577	581	579	570
Change in income		20	25	20	12	4	-2	-9
Net investment		40	50	40	24	8	-4	-18

Investment peaks in year 3, when growth is fastest, though income rises until year 6. Investment falls from year 4, so the slowdown starts before output peaks. A fall of 10 in investment (50 to 40) with k = 2.5 lowers income by 25.

The cycle. Rising income raises investment through the accelerator. That investment raises income again through the multiplier, so expansion feeds on itself. When growth slows, investment falls even though income is still rising, and the multiplier works in reverse. Once capital wears out, firms must replace it, investment recovers and the cycle restarts.

Evaluation. The model assumes spare capacity and a constant v. Real firms invest on expected demand, and policy can interrupt the cycle. It explains turning points but cannot time them.

6. Output gaps

The output gap measures how far actual real GDP is from potential real GDP.

Output gap (%) = (actual - potential) / potential x 100

A negative output gap arises when output is below potential, leaving spare capacity. A positive output gap arises when output is above the sustainable level, so resources are overstretched.

Three diagrams

• Cycle diagram: the gap is the vertical distance between the actual wave and the trend line, negative below it and positive above.
• AD/AS: draw LRAS as a vertical line at potential output. If AD meets SRAS to the left of LRAS, the gap is negative. If it meets to the right, the gap is positive. If potential output in the earlier AD/AS example is 850, the gap is (800 - 850)/850 = -5.88% before the spending rise and (830 - 850)/850 = -2.35% after.
• PPF/C: a point inside the curve is a negative gap (unemployed resources). A positive gap cannot be a sustainable point outside the curve. It is shown as production at or just beyond the normal-capacity curve, using overtime, with resources overstretched.

Country S (illustrative) has frontier points (capital goods, consumer goods) of (0, 200), (40, 180), (70, 140), (90, 80) and (100, 0). If it makes 40 capital goods and 144 consumer goods, it is 36 below the frontier, 20% of the 180 possible.

Gaps over a cycle (potential grows 2.5% a year from 1,000 in year 1):

Year	1	3	5	6
Potential	1,000.0	1,050.6	1,103.8	1,131.4
Actual	960.0	1,081.2	1,040.0	1,052.0
Gap (%)	-4.00	2.91	-5.78	-7.02

Causes of an output gap

• Negative gap: a fall in consumption, investment, government spending or exports, tight credit, a currency rise that hurts exports, or a financial crisis. With sticky wages and prices, weak AD leaves output below potential.
• Positive gap: an AD boom from cheap credit, tax cuts, rising asset prices or an export surge, with AD outgrowing potential output.

Evaluate by the size and speed of the shock and how flexible wages and prices are. Potential output cannot be observed, so any measured gap is an estimate.

Consequences of an output gap

• Negative: unemployment, lost output, falling profits and tax revenue, low inflation or deflation, a wider budget deficit, weak investment, and lasting damage if it persists.
• Positive: faster inflation, labour shortages, a worse trade balance as imports are pulled in, and risk of an asset bubble followed by a bust. Low unemployment and higher profits are short-lived benefits.

Evaluation: effects depend on the size and duration of the gap, who is affected, and whether market forces or policy close it.

Common errors

• Using 1/(1 - MPC) when there are taxes and imports.
• Treating the AD shift as the final change in real GDP when SRAS slopes upward.
• Saying accelerator investment depends on the level of income, not its change.

Official syllabus

OCR, A Level in Economics (H460), Version 3.0 (June 2026), first assessment 2021, Component 2 content: Aggregate demand and aggregate supply, topic The economic cycle. Published by OCR (Oxford Cambridge and RSA).