2.4.4 - The multiplier

Question 1

Define multiplier effect

Answer 1

When an increase in AD caused by an increased injection (investment, government spending, export) can lead to an further increase in national income

Question 2

Effect of the multiplier on the economy

Answer 2

. The multiplier means that growth can occur quicker, as any injections lead to a greater shift in AD, thus greater increase or decrease in national income

. Injections are usually targeted at those with the greatest marginal propensity to consume, as this will have the greatest impact on national income. Low income households have a higher MPC

(Can be used for Evaluation. Injections will only be useful if use for those with the greater MPC)

. There will be a time lag between the injection and the full effect as money will not be spent immediately

(Evaluation)

Question 3

Effect on injections in multiplier effect

Answer 3

Investment, government spending and exports are injections into the circular flow

If the multiplier was 2, then an injection (e.g. £100 million investment) would lead to an increase in national income of £200 million in the first round

A fall in exports of £500 million would lead to a fall in national income of £1,500 million if the multiplier was 3. In the next round, the fall in national income would be £4,500 million. This is a negative multiplier effect; withdrawals from the economy could lead to a even further fall in national income

Question 4

Effect of withdrawals on multiplier

Answer 4

. Withdrawals / leakages refers to saving, taxing and importing

. Withdrawals as as well as consumption affect the multiplier

. An increase in the marginal propensity to consume comes about because one or more the marginal propensities to save, tax or import have fallen

. The higher the leakages from the circular flow, the smaller the increase in income which continues to flow around the economy at each stage following an initial increase in spending. Hence the higher the leakages, less consumption and thus a smaller value of the multiplier

Question 5

Significance of the multiplier for AD

Answer 5

. An injection (exports, government spending, investment) will lead to a shift to the right of the AD curve. The size of the rise in equilibrium national income will be the value of the rise in injection (initial rise in AD) times multiplier.

. A withdrawal or fall in injections will lead to a shift to the left of the AD curve. The size of the fall in equilibrium national income will be the value of the fall in withdrawals (initial fall in AD) times the multiplier. This is the demultiplier effect

. The multiplier leads to an increase in AD higher than the original increase but for it to
have the desired effect, there must be sufficient spare capacity in the economy (i.e.
it cannot be at full output) for extra output to be produced. (Evaluation)

. The larger the multiplier, the greater the affect on the economy and national income, as an injection or withdrawal will lead to a greater shift of the AD curve.

Question 6

Effects of the economy / government on the multiplier

Answer 6

. Multiplier determined by MPC, MPT, MPC, MPS and MPM

. An increase in interest rates will lead to a fall in MPC and rise in MPS, which would lead to a fall in multiplier

. A rise in household wealth would raise the MPC, increasing the multiplier value

. A rise in taxes would increase the proportion of income paid in tax, increasing the MPT and fall in MPC, thus reducing the value of the multiplier

. Any factor APART FROM INCOME that changes imports will affect the multiplier. E.g. an improvement in quality of imported goods would encourage households to buy more imports. increasing MPM, thus reducing the value of multiplier