The Multiplier Flashcards
Describe the Multiplier Effect
When injections of new demand for goods and services into the circular flow of income stimulate further rounds of spending
Consequences of the multiplier effect
Increase in Real National Output and Total Employment
Formula for multiplier (closed economy no gov)
Multiplier = 1 / (marginal propensity to save)
Formula for Multiplier (closed economy with gov)
1 / (sum of the marginal propensity to save + marginal rate of tax)
Formula for multiplier (open economy with gov)
Multiplier = 1 / (sum of the propensities to save + tax + import)
Positive Multiplier Effect
When an initial increase in an injection (or a decrease in a leakage) leads to a greater final increase in real GDP
Negative Multiplier Effects
When an initial decrease in an injection (or an increase in a leakage) leads to a greater final decrease in real GDP
When is there a higher multiplier value
Economy has plenty of spare capacity to meet higher AD
MP to Import and Tax is low
High propensity to consume any extra income
When is there a low multiplier value
Economy is close to its capacity limits
Propensity to import is high
Higher inflation causes rising interest rates
Formula for Marginal Propensity to Save
Change in Savings / Change in Income
Formula for Marginal Propensity to Consume
Change in Consumption / Change in Income
Formula for Marginal Propensity to Tax
Change in Taxation / Change in Income
Formula for Marginal Propensity to Impott
Change in Spending on Imports / Change in Income
Formula for Marginal Propensity to Withdraw
MPW = MPS + MPM + MPT
Effect of Multiplier on AD
Higher multiplier - injections have larger impact on National Income - AD increases by a larger amount
