2.4.4 The Multiplier

Question 1

What is the multiplier effect?

Answer 1

A change in one of the components of AD can lead to a multiplied final change in the equilibrium level of GDP i.e. a change in injections leads to a more than proportional increase in real GDP

Question 2

How does the multiplier effect come about?

Answer 2

• The multiplier effect comes about because injections of new demand for goods and services into the circular
  flow of income stimulate further rounds of spending – because “one person’s spending is another’s income”
• This leads to a bigger final effect on national output and also total employment in the labour market

Question 3

How do you calculate the total change in real GDP?

Answer 3

Total change in real GDP = injection x multiplier

Question 4

The bigger the multiplier, what happens to the change in real GDP?

Answer 4

The bigger the multiplier, then the bigger the change in real GDP! The multiplier is larger when withdrawals from the circular flow are smaller.

Question 5

What is the marginal propensity to consume (MPC)?

Answer 5

The proportion of additional income that is spent in the domestic economy

Question 6

What is the marginal propensity to import (MPM)?

Answer 6

The proportion of additional income that is spent on imports

Question 7

What is the marginal propensity to save (MPS)?

Answer 7

The proportion of additional income that is saved

Question 8

What is the marginal propensity to tax (MPT)?

Answer 8

The proportion of additional income that is paid to the government as tax

Question 9

What is the marginal propensity to withdraw? (MPW)

Answer 9

The proportion of additional income leaving the circular flow (i.e. the sum of the MPM, MPS and MPT)

Question 10

What is formula for the multiplier in a closed economy with no government?

Answer 10

The calculation for the value of the multiplier is:
Multiplier = 1 / (marginal propensity to save)
Or
Multiplier = 1 / (1-marginal propensity to consume)

Question 11

What is formula for the multiplier in a closed economy with a government?

Answer 11

Multiplier = 1 / (sum of the marginal propensity to save + marginal rate of tax)

Question 12

What is formula for the multiplier in a open economy with a government?

Answer 12

Multiplier = 1 / (sum of the propensities to save + tax + import)

Question 13

Explain what happens when the UK government injects £200m into a project to build thousands of affordable new houses.

Answer 13

• A new house building project injects £200m of extra demand and output into the economy
• Many businesses benefit directly including building supply industries, engineers, architects etc.
• Constructing houses generates an extra flow of factor incomes – including higher wages and profits
• Will the extra incomes stay inside the circular flow of income and spending?
• If so, the multiplier effect is likely to be strong and the final impact on GDP could be large

Question 14

How can the multiplier be used for evaluation?

Answer 14

The impact of x depends on the size of the multiplier…in
the UK, the savings ratio is low but the MPM is high so overall AD might not rise by much.

Question 15

What is the positive multiplier?

Answer 15

When an initial increase in an injection (or a decrease in a leakage) leads to a greater final increase
in real GDP.

Question 16

What is the negative multiplier?

Answer 16

When an initial decrease in an injection (or an increase in a leakage) leads to a greater final decrease
in real GDP.

Question 17

What does the size of the multiplier effect depend on?

Answer 17

The size of the multiplier effect depends in part on the extent to which people spend or save any additional disposable income (MPC or MPS).

Question 18

What is the multiplier process look like?

Answer 18

Question 19

When is there a high multiplier value?

Answer 19

Question 20

When is there a low multiplier value?

Answer 20