2.4.4 - The Multiplier

Question 1

What is the multiplier effect

Answer 1

A change in injections leads to a more than proportional increase in real GDP

Question 2

How do you calculate the multiplier ratio

Answer 2

Total change in real GDP = injection x multiplier

Question 3

What is the formula for multiplier

Answer 3

• multiplier = 1 / marginal propensity to save
• multiplier = 1 / 1 - marginal propensity to consume
• multiplier = 1 / (sum of marginal propensities to save + tax + import)

Question 4

Give an example of the multiplier process

Answer 4

• new house building project injects £200m of extra demand and output into economy
• many businesses benefit directly e.g. building supply industries
• constructing houses generates an extra flow of factor incomes
• if extra income stays inside circular flow the multiplier effect is strong and the final impact on GDP is large

Question 5

What is a positive multiplier

Answer 5

when an initial increase in an injection leads to a greater final increase in GDP

Question 6

What is a negative multiplier

Answer 6

When an initial decrease in an injection leads to a greater final decrease in GDP

Question 7

What is the formula for marginal propensity to consume

Answer 7

Change in total consumption / change in gross income

Question 8

What is the formula for marginal propensity to save

Answer 8

Change in total savings / change in gross income

Question 9

What factors will cause a high value multiplier

Answer 9

• economy has plenty of spare capacity to meet higher aggregate demand
• marginal propensity to import and tax is low
• high propensity to consume any extra income

Question 10

What factors cause a low multiplier value

Answer 10

• economy is close to its capacity limits
• propensity to import goods and services is high
• higher inflation caused rising interest rates with dampens other components of AD