Topic 1.5- The Multiplier & Accelerator

Question 1

What is the multiplier

Answer 1

The ratio of the rise in GNI compared to the initial rise in AD

Question 2

How does the multiplier process work

(use the example of government building investing in new roads)

Answer 2

If the government were to spend 1 billion building new roads,

Contractors are hired to build those roads,
Contractors receive additional income,
Contractors spend (and save) their new income

Let’s say that they spend it at a coffee shop.
Now the coffee shop owners have an additional income,
So they can spend this elsewhere.

This keeps going on and on.

Essentially,
Increase in income for contractor,
Increase in consumption from contractor at coffee shop,

Increase in income for coffee shop owner
Increase in consumption from coffee shop owner elsewhere

Question 3

What does the word ‘Propensity’ mean

Answer 3

A tendency.
What is likely to happen.

Question 4

What is the Average Propensity to Consume

Answer 4

The amount of consumption compared to income.

Question 5

What is the Marginal Propensity to Consume

Answer 5

How much an increase in income will be devoted to consumption.

Question 6

How does the MPC affect the multiplier

Answer 6

The larger the MPC, the larger the multiplier since:
Multiplier = 1 / (1-MPC)

Question 7

What is the Marginal Propensity to Save

Answer 7

How much an increase in income will be devoted to savings

Question 8

How does the MPS affect the multiplier

Answer 8

The higher the MPS the smaller the multiplier since:
MPC + MPS = 1
&
Multiplier = 1 / (1-mpc)

Question 9

Calculate the Multiplier when the MPS is 0.7 compared to when the MPS is 0.4.
Compare the size of the Multiplier

Answer 9

MPS = 0.7
=> MPC = 0.3
=> Multiplier = 1 / (1-0.3)
=> Multipler = 1.43 (2dp)

MPS = 0.4
=> MPC = 0.6
=> Multiplier = 1 / (1-0.6)
=> Multiplier = 2.5

So as MPS decreases, Multiplier Increases

Question 10

How does the Marginal Propensity to Import (MPM) affect the Multiplier

Answer 10

Since imports are a leakage from the circular flow of income,
Income is lost,
MPS increases
So multiplier decreases

Question 11

How does the Marginal Propensity to Tax (MPT) affect the Multiplier

Answer 11

If a large proportion of additional income earnt is taxed,
Lower disposable income,
Lower MPC,
Lower Multiplier