3.2 Multipliers

Autonomous expenditures - the spending consumers must do even if they have zero disposable income; spending that is independent of an increase in income,

  • in contrast to induced spending

  • example: basic food/shelter, essential utilities, government public infrastructure, AN INCREASE IN GOVERNMENT SPENDING!!!   

    • The government decreasing tax also has a multiplier effect, though it is always one smaller than the expenditure multiplier because their is one fewer transaction involving production


Induced expenditures - spending that is the direct result of an increase in income.

  • example: upgraded housing or vehicles; discretionary & luxury spending

  • Marginal propensity to consume (MPC) and the marginal propensity to save (MPS) determine how much induced spending there is.

    • Marginal Propensity to Consume - the fraction of each additional dollar of income that households will spend, expressed as a number between 0 and 1.

    • Marginal Propensity to Save - the fraction of each additional dollar of income that households will save, expressed as a number between 0 and 1.

    • ⭐ The MPC and MPS will always total one (because they reflect the two basic things you can do with one additional dollar of income: you can spend it or save it)


Spending multiplier - the principle that any autonomous expenditure will result in a change in aggregate demand by a maximum value of the expenditure multiplied by 1/MPS, or the inverse of the marginal propensity to consume.

Tax multiplier - the principle that any change in taxes will result in a change in aggregate demand up to the dollar value of the tax change multiplied by MPC/MPS, or the marginal propensity to consume divided by the marginal propensity to save; the impact is negative


The multiplier formulas:

  • MPC and MPS

  • Spending multiplier

  • Tax multiplier


⭐️ The vast majority of induced spending would fall in household consumption.1


Example:

  1. The MPS is 0.25. If the government decreases spending by $10 billion, what is the maximum total spending change in the economy?


  1. If the MPC is 0.8, what will be the impact of a $10 million government spending decrease and a $10 million tax decrease?


⭐️ You calculate MPS by dividing the change in savings by the change in disposable income.

  • example: if savings rise by $300 when income rises by $1000, MPS = 300/1000 = .3