The Multiplier Flashcards
What is the multiplier ratio?
Quantifies the total change in national income resulting from an initial change in spending.
Formula of the multiplier
1/(1-MPC)
Alternative of multiplier formula
1/MPW
What is the multiplier process?
1) Initial spending: Increase in spending injects money into economy
2) Income generation: This becomes income for households and firms who spend this portion of income
3) Secondary spending: This generates additional income for others, continuing the cycle
4) Diminishing returns: Each round of spending is smaller due to withdrawals, eventually tapering off.
How does the multiplier cause economic expansion?
- Multiplier amplifies the effects of initial spending increases, leading to overall economic growth
- Job creation through increased demand for goods
- Income growth through increased demand, boosting living standards.
How does the multiplier cause economic contraction?
- A reduction in spending can have multiplied negative effects, leading to a deep recession
- Unemployment increases due to lower demand
- Decreased income
Marginal Propensity to Consume definition
The fraction of additional income households spend on consumption.
Marginal Propensity to Save definition
The fraction of additional income households save.
Marginal Propensity to Tax definition
The fraction of additional income that is spend on tax.
Marginal Propensity to Import definition
The fraction of additional income spent on imports
How does the multiplier reflect on AD?
- The multiplier effect means that an initial increase in AD causes an even larger increase on national income and output.
- From AD1 to AD3.
How does the effects of the multiplier on AD help policy making?
- Allows policy makers to make effective fiscal policies in response to cycle changes
- Austerity measures (relative to spending)
- Fiscal stimulus to combat recessions, now knowing the amplification of the multiplier effect on growth.
