2.4.4: The multiplier

What is the multiplier process

• The idea than an increase in AD because of an increase in injections can lead to a further increase in national income

• It is the ratio of the final change in income to the initial change in injection

• The figure multiplied by the original injection to find the final change in income

• The inital increase in sending will increase income for someone else which will then lead to further consumption spending

• The size of he multiplier is determined by people’s MPC- the lower leakages, the higher MPC, the bigger the multiplier

• The concept is able to work due to the circular flow

• A negative multiplier can also occur- a withdrawal can lead to an even further fall in income which decreases growth

Effects on the eocnomy

• Growth can occur quicker as any injection lead to an increase in NI

• Injections can be targeted at those with higher MPCs in order to increase the size of the multiplier e.g: benefit recipients, pensioners, those on low incomes

• Governments use changes in spending to influence macroeconomic performance, but it is impossible for them to know the exact effect of their spending as it is difficult to to know the size of the multiplier

Marginal propensity to consume

• The increase in consumption following an increase in income

Marginal propensity to save

• The increase in savings follow an increase in income

Marginal propensity to tax

• The increase in taxation following an increase in income

Marginal propensity to import

• The increase in imports following an increase in income

Marginal propensity to withdraw

• The increase in leakages following an increase in income

• MPW= MPS+MPT+MPM

How to calculate the multiplier

• 1/1-MPC Or 1/MPW

Effects of a change in AD

• The multiplier leads to an increase in AD higher than the original increase

• For it to have the desired effect, there must be sufficient spare capacity in the economy for extra output to be produced

• If the AS is perfectly inelastic like on the classical LRAS curve, the only impact of the multiplier will increase price and not affect long run output

• The more elastic the curve, the smaller effect on price but bigger effect on output

• Therefore, the effect of the multiplier depends on the shape of the AS curve and whether it is short run or long run

• The size of increase in AD depends on both size and increase in AD and the size of the multiplier

• The multiplier will have a big effect when there is plenty of spare capacity and the MPW is low, MPC is high