The Multiplier

Question 1

The Multiplier

Answer 1

The multiplier effect occurs when an initial injection into
the circular flow causes a bigger final increase in real national income.
This injection of demand might come for example from a rise in exports
X, investment I or government spending G.

Question 2

The multiplier process

Answer 2

The multiplier effect arises because one agent’s spending is another
agent’s income. When a spending project creates new jobs for
example, this creates extra injections of income and demand into a
country’s circular flow.
The negative multiplier effect occurs when an initial withdrawal or
leakage of spending from the circular flow leads to knock-on effects
and a bigger final drop in real GDP.

Question 3

The Multiplier Coefficient

Answer 3

The multiplier coefficient itself is found by:

Final change in real GDP / Initial change in AD

Example: If the government increased spending by £5 billion but this
caused real GDP to increase by a total of £12 billion, then the
multiplier would have a value of 12/5 = 2.4

Question 4

Multiplier formula

Answer 4

Multiplier k = 1/(1 - MPC) where the MPC = the marginal
propensity to consume
MPC = change in consumption/change in income = change in C/change
in Y
Initial change in injections x k = final change in national Y
Example: if investment increases by £100bn and the MPC = 0.8, the
final increase in real GDP will be £100bn x 1/(1-0.8) = £500bn

Question 5

Other multiplier formulae

Answer 5

In a closed economy with no government: k = 1/MPS
In a closed economy with a government k = 1/(MPS + MPT)
In an open economy with a government k = 1/(MPS + MPT + MPM) or 1/MPW
Where MPS = marginal propensity to save, MPT = marginal propensity to tax, MPM = marginal
propensity to import and MPW = marginal propensity to withdraw

Question 6

Factors influencing the size of the multiplier

Answer 6

High multiplier value
* Economy has plenty of spare capacity
* Propensity to import and tax is low
* High propensity to consume any
extra income

Low multiplier value
* Economy is close to full capacity
* Rising demand causes inflation
* Higher inflation causes rising
interest rates

Question 7

Evaluation of multiplier

Answer 7

• Difficult to know exact size of multiplier - hard to measure
• Takes time for multiplier process to feed through to real GDP – time lag
• Economists disagree over its size
• Long run multiplier effect is likely higher for developing economies than for
  developed ones; infrastructure projects often have higher multiplier effects