2.4.4 The Multiplier

Question 1

What is the multiplier

Answer 1

change in one component of AD can lead to a multiplied final change in the equilibrium level of GDP

i.e. a change in injections leads to a more than proportional increased in AD

Question 2

Why does the multiplier come about

Answer 2

It comes about because injections of new demand for good/services into the circular flow of income stimulates further rounds of spending

This leads to a bigger final effect on national output + total employment in the labour market

Question 3

What is the multiper ratio

Answer 3

total change in real GDP = injections x multiplier

The bigger the multiplier, the bigger the change in GDP

Question 4

When is the multiplier effect large

Answer 4

when withdrawals from the circular flow are smaller

Question 5

Marginal Propensity to consume

(MPC)

Answer 5

The proportion of additional income is spent in the domestic economy

Question 6

Marginal Propensity to import

(MPM)

Answer 6

The proportion of additional income that is spent on income

Question 7

Marginal Propensity to Save

(MPS)

Answer 7

The proportion of additional income that is saved

Question 8

Marginal Propensity to Tax

(MPT)

Answer 8

The proportion of additional income that is paid to the government in tax

Question 9

What is the formula for the multiplier in a closed economy and no Government

Answer 9

1 / Marginal propensity to save

or

1 / (1 - Marginal propensity to consume)

Question 10

What is the formula for the multiplier in an open economy and government

Answer 10

1 / (Σ Marginal propensity to tax + import + save)

Question 11

What does the Keynesian multiplier effect focus on

Answer 11

extra demand + factor income created

Question 12

Give an example of the multiplier if the Government:

injects £200 mil into a project on affordable housing

Answer 12

• causes extra demand and output with the £200 mil
• Businesses benefit from increased demand e.g building supplies
• Extra flow of factor income = wages + profits
• Hence impact on GDP

Question 13

The size of the multiplier depends on

Answer 13

Marginal propensity to save or consume

Saving is a leakage

Consumption/Spending is an injection

Question 14

When is the multiper effect high

Answer 14

• High spare capacity (negative output) to meet increased Aggregate demand
• Marginal Propensity to tax and import is low
• High marginal propensity to consume

Question 15

Low multiplier effect when

Answer 15

• Economy is close to full capacity e.g. boom phase
• Propensity to import is high = leakages
• High inflation causing interest rates to rise which dampens the effect of the components of AD