2.4.4 The Multiplier

Question 1

What decides the size of a multiplier?

Answer 1

The size of the multiplier will be determined by how much of an increase in income people will spend, the marginal propensity to consume (MPC). The higher the MPC, the bigger the multiplier.

Question 2

How do the government exploit the multiplier?

Answer 2

Inject money into those who have the highest MPC (usually lower income people)

TIME LAG

Question 3

What factors affect MPC?

Answer 3

Any component of AD

Question 4

What does “Marginal Propensity” actually mean?

Answer 4

How much of additional income is used to save, tax, consume, import etc.

Question 5

Formula for multiplier?

Answer 5

Multiplier = 1 / (1 - MPC)

Question 6

What does the multiplier require (EVAL POINT)

Answer 6

There must be sufficient spare capacity in the economy.

If the AS is perfectly inelastic, like on the classical LRAS curve, then the only impact of the multiplier will be to increase price; it will not affect output in the long run. (will on keynesian and SRAS diagrams though).

Therefore, as with any increase in AD, the effect of the multiplier depends on the shape of the AS curve and whether it is short run or long run.