Macro - The Multiplier

Question 1

Multiplier ratio

Answer 1

This is the ratio of a change in real income to the initial injection that brought it about.
For example if a £2M injection in to the Circular Flow caused a £4M increase in national income then the value of the multiplier would be 2

Question 2

Multiplier process

Answer 2

One persons spending is another persons income. For example an injection into the Circular Flow such as export revenue will result in immediate increase in AD however some of the money will go into the other countries economy.

Question 3

Explain the effects of the economy on the multiplier

Answer 3

The initial injection causes an increase in AD shifting it to the right then this injection will cause income for someone else to increase which would then shift AD again to the right making the graph have 3 AD curves.

Question 4

The marginal propensity to consume (MPC)

Answer 4

This is the proportion of extra income that is spent in the economy. For example if it was 0.6 (60%) then the multiplier effect would be much larger than if the MPC was 0.4 (40%)

Question 5

The marginal propensity to save (MPS)

Answer 5

This is the proportion of extra income that is saved. The bigger the MPS value is, the smaller the multiplier. This is because more of the extra income will be withdrawn from the economy rather than being kept in the circular flow of income. Therefore, the second increase in AD will be small compared to if the MPS value was small.

Question 6

The marginal propensity to tax (MPT)

Answer 6

This is the proportion of extra income that goes to the government in the form of taxation. The larger the value of MPT, the smaller the multiplier effect will be. This is because taxation is one of the leakages in the circular flow. Therefore, the larger the proportion of extra income that gets taxed, the more of that extra income is going out of the circular flow.

Question 7

The marginal propensity to import (MPM)

Answer 7

This is the proportion of extra income that is spent on imports. The larger the value of MPM, the smaller the multiplier effect will be. This is because instead of the majority of that extra income being spent in the economy, it will be injected into the circular flow of the country that the domestic consumer is spending their extra income buying imports from.

Question 8

Formulas to calculate the multiplier

Answer 8

1/(1-MPC)
1/MPW
1/MPS

Question 9

The significance of the multiplier to shifts in AD

Answer 9

As shown from the following examples, the greater the marginal propensity to consume, the greater the multiplier effect and therefore the greater the increase in AD.