The Multiplier Effect

Question 1

What is the Multiplier Effect?

Answer 1

• Injections into the circular flow of income eventually lead to an even bigger increase in national income
• This is the multiplier effect
• Value of the multiplier is also known as the multiplier ratio

Question 2

What is the Multiplier determined by?

Answer 2

• Size of withdrawals from the circular flow

- Larger withdrawals = a lower multiplier

Question 3

What is the Marginal Propensity to Save?

Answer 3

• The proportion of any extra income that is saved

- Change in Savings/Change in Income

Question 4

What is the Marginal Propensity to Consume?

Answer 4

• The proportion of any extra income that is spent on goods and services
• Change in Consumption/Change in Income

Question 5

What to MPS and MPC add up to?

Answer 5

1

Question 6

Why are people with lower incomes likely to have higher MPC’s?

Answer 6

• They tend to be unable to afford the basics

- Therefore they are more likely to be spend any extra income they get

Question 7

What is the Marginal Propensity to Tax?

Answer 7

• Any new income that is paid as tax

- Change in Taxation/Change in Income

Question 8

What is Marginal Propensity to Import?

Answer 8

• Any new income that is spent on Imports

- Change in Spending on Imports/Change in Income

Question 9

What is the Marginal Propensity to Withdraw?

Answer 9

• The proportion of extra income that is withdrawn from the economy
• MPW = MPS + MPM + MPT

Question 10

How do you work out the Multiplier Value from the MPW or MPC?

Answer 10

1/MPW
- e.g if MPW 0.5 then 1/0.5 = 2 as multiplier value
1/1-MPC

Question 11

How does a higher Multiplier affect AD?

Answer 11

A higher multiplier means injections have a larger impact on National Income and hence AD increases by a larger amount

Question 12

What are the effects of the increase in AD?

Answer 12

• Higher output & Economic Growth
• Higher employment due to increase need for labour from firms
• Higher inflation provided economy is not in a recession
  (Refer to Keynesian curve as he originated the multiplier theory)

Question 13

What factors effect the value of the Multiplier?

Answer 13

• Anything that affects the MP…
• e.g Higher wealth may encourage consumption
• or Higher interest rates may discourage consumption
• These type of factors affect the multiplier

Question 14

What is the Equation for the multiplier?

Answer 14

Multiplier Ratio (K) = Change in Real GDP (Y) / Change in Injections (J)