2.4.4 The multiplier

Question 1

What is the Multiplier process?

Answer 1

An increase in AD because of an ​increased injection ​(exports, government spending or investment) can lead to a ​further increase in national income. It occurs since ‘one person’s spending is another person’s income’.

Question 2

if the government spends £100m to create jobs and withdrawals are taken into account, the £100m of government spending could lead to an extra £90m being spent by those who have the jobs, of which another £81m will be spent by those who received the £90m and so on. In this case, the MPC is 0.9 and the multiplier is 10. The extra consumption creates more jobs and increases output.

Answer 2

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Question 3

Marginal Propensity to Consume (MPC) on the multiplier?

Answer 3

• The higher the MPC, the bigger the size of the multiplier

Question 4

How could the government could influence the MPC?

Answer 4

By changing the rate of direct tax, if consumers have more disposable income due to lower income tax rates, their propensity to consume might increase.

Question 5

How can a negative multiplier effect occur?

Answer 5

• Withdrawal from the economy could lead to an even further fall in income, decreasing economic growth and possibly leading to a decline in the economy

Question 6

Multiplier equations

Answer 6

1/(1-MPC)

Question 7

If consumers spend 0.6 of every £1 they earn, they save 0/4. Therefore, the multiplier will be:
1/(1-0.6) = 1/0.4 = 2.5.
This means that every £1 of income generates £2.50 of new income.

Answer 7

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Question 8

e.g. If MPC is 0.9 and the increase in government spending is £50,000, what will the increase in national income be?
Multiplier = ​ 1 ​ =10 1-0.9
Increase in national income: 50,000 x 10=£500,000

Answer 8

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Question 9

What has to be present for the multiplier effect to affect AD?

Answer 9

Spare capacity