The multiplier effect describes how an initial change in spending, such as an increase in government spending, causes a multiplied impact on national income through subsequent rounds of spending. The size of the multiplier effect depends on the marginal propensity to consume (MPC), which is the proportion of additional income that is spent. A higher MPC leads to a larger multiplier, as more of each additional dollar is spent and respent in the economy. In an open economy, the multiplier is reduced by spending on imports and taxation, which leak out of the domestic economy.
The multiplier effect describes how an initial change in spending, such as an increase in government spending, causes a multiplied impact on national income through subsequent rounds of spending. The size of the multiplier effect depends on the marginal propensity to consume (MPC), which is the proportion of additional income that is spent. A higher MPC leads to a larger multiplier, as more of each additional dollar is spent and respent in the economy. In an open economy, the multiplier is reduced by spending on imports and taxation, which leak out of the domestic economy.
The multiplier effect describes how an initial change in spending, such as an increase in government spending, causes a multiplied impact on national income through subsequent rounds of spending. The size of the multiplier effect depends on the marginal propensity to consume (MPC), which is the proportion of additional income that is spent. A higher MPC leads to a larger multiplier, as more of each additional dollar is spent and respent in the economy. In an open economy, the multiplier is reduced by spending on imports and taxation, which leak out of the domestic economy.
The multiplier effect describes how an initial change in spending, such as an increase in government spending, causes a multiplied impact on national income through subsequent rounds of spending. The size of the multiplier effect depends on the marginal propensity to consume (MPC), which is the proportion of additional income that is spent. A higher MPC leads to a larger multiplier, as more of each additional dollar is spent and respent in the economy. In an open economy, the multiplier is reduced by spending on imports and taxation, which leak out of the domestic economy.
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The Multiplier Effect
A change in the level of injections or withdrawals will result in a bigger or multiplied change in the level of national income. The size of this change will depend upon peoples desire or propensity to spend any extra income that they receive. The more they spend of any extra income received, i.e. the higher their marginal propensity to consume the greater this multiplier effect will be. If people in general spend 80% of any extra income they earn, their marginal propensity to consume (MPC) is 0.8 M.P.C.can therefore be calculated as CHANGE IN CONSUMPTION CHANGE IN INCOME In the diagrams below, the initial equilibrium levels of national income are indicated by E. In order to increase this level Government spending (G) is increased by the same amount in each of two economies. In the left-hand diagram, MPC is high. You can see the effect on national income (Y) of this government spending as it works its way round the economy in successive spending rounds (look at the horizontal gap between E and E+) In the right-hand diagram MPC is lower. The change in national income created by the same change in Government spending is lower, because the multiplier effect is lower.
HIGH MPC AD line is steep as
LOW MPC AD line is less steep as
AD1
people spend a high proportion of
any extra income
people spend a lower proportion of any
extra income
AD1
AD
AD G G
NATIONAL INCOME (Y)
E+
NATIONAL INCOME (Y)
E+
Look at the gaps between E and E+ in both diagrams. What do
you notice? 1
The Multiplier effect or the National Income Multiplier can be described as:
The Change in National Income
The change in Injection or Withdrawal
eg: 100 billion
20 billion
MULTIPLIER = 5
It is calculated by this formula:
1 1 MPC As you will see from worked examples, the higher the MPC the higher the value of the multiplier
Example 1 If MPC = 0.75 Then the Multiplier =
1 = 1 0.75
1 0.25
So, for every injected or withdrawn from the economy there is a change of 4 in national income
Example 2 If MPC = 0.4
Calculate the multiplier
What do you notice?
THE MULTIPLIER IN AN OPEN ECONOMY
This formula will always work:
1 1 MPC In an open economy, that is one that engages in foreign trade (as all economies do) MPC, that is the spending taking place in the domestic economy will be reduced by the level of money spent on imports. It will also be affected by the general level of taxation. To give a true full picture of the value of the national income multiplier, we therefore need to take spending on imports and the level of taxation into account. The full multiplier can therefore be expressed as
1 s+t+m
What do you notice about these
three elements? Collectively they are
where s = the proportion of national income saved
t = the proportion of national income taxed m = the proportion of national income spent on imports
