2.4.4 The Multiplier

Question 1

What is the multiplier ratio?

Answer 1

The multiplier ratio quantifies the total change in national income resulting from an initial change in spending. It demonstrates how initial spending generates further income and consumption, leading to a multiplied effect on the overall economy.

Multiplier = 1 / (1 - MPC)
Alternatively, Multiplier = 1 / MPW, where MPW (Marginal Propensity to Withdraw) = MPS + MPT + MPM.

Question 2

What is the multiplier process?

Answer 2

1. Initial Spending: An initial increase in spending (e.g., government investment, export demand) injects money into the economy.
2. Income Generation: This spending becomes income for households and firms, who then spend a portion of this income.
3. Secondary Spending: The subsequent spending generates additional income for others, continuing the cycle.
4. Diminishing Returns: Each round of spending is smaller due to withdrawals (savings, taxes, imports), eventually tapering off.

Question 3

What are potential effects of the multiplier on the economy?

Answer 3

Economic Expansion:

The multiplier amplifies the effects of initial spending increases, leading to greater overall economic growth.
Job Creation: Increased demand for goods and services requires more labor, reducing unemployment.
Income Growth: Higher demand raises incomes, enhancing living standards.
Economic Contraction:

Conversely, a reduction in spending can have a multiplied negative impact, leading to deeper recessions.
Increased Unemployment: Lower demand reduces the need for labor, increasing unemployment.
Decreased Income: Reduced economic activity leads to lower incomes and consumption.

Question 4

What is Marginal Propensity to Consume?

Answer 4

MPC: The fraction of additional income that households spend on consumption. Higher MPC results in a larger multiplier as more income is recycled into the economy.

Question 5

What is
- marginal propensity to save
- marginal propensity to tax
- marginal propensity to import?

Answer 5

Marginal Propensity to Save (MPS): The fraction of additional income that households save. Higher MPS leads to a smaller multiplier as more income is withdrawn from the spending cycle.

Marginal Propensity to Tax (MPT): The fraction of additional income that is paid in taxes. Higher MPT reduces the multiplier as more income is diverted to the government.

Marginal Propensity to Import (MPM): The fraction of additional income spent on imports. Higher MPM decreases the multiplier as income leaks out of the domestic economy.

Question 6

What is The Significance of the Multiplier for Shifts in AD?

Answer 6

The multiplier effect means that an initial increase in AD results in a larger overall increase in national output and income