The Multiplier Flashcards
What is the Multiplier Effect?
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.
What is the Multiplier Coefficient?
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
Factors influencing the size of the multiplier?
Higher multiplier value:
• Economy has plenty of spare capacity
• Propensity to import and tax is low
• High propensity to consume any extra income
Lower multiplier value:
• Economy is close to full capacity
• Rising demand causes inflation
• Higher inflation causes rising interest rates
What is the negative multiplier effect?
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.
What is the multiplier formula?
Multiplier k = 1/(1-mpc) where the MPC = the marginal
propensity to consume
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
How would you show the multiplier effect on a diagram?
Initial increase in AD from AD1 to AD2
increases real GDP from Y1 to Y2. This then
kicks off a multiplier effect which increases AD
further to AD3 and real GDP rises to Y3.
Investment multiplier – initial change from I
Fiscal multiplier – initial change from G or
government borrowing
Export multiplier – initial change from X
