2 - Multiplier

Question 1

What is the multiplier effect?

Answer 1

Occurs when an initial injection into the circular flow causes bigger final increase in real national income

Question 2

Why does it arise?

Answer 2

One agents spending is another agents income
- eg. When a spending project creates new jobs, this creates extra injections of income and demand into circular flow

Question 3

When does negative multiplier effect occur?

Answer 3

Initial withdrawal or leakage of spending for circular flow leads to knock on effects and a bigger final drop in real GDP

Question 4

Multiplier coefficient calculation

Answer 4

Final change in real GDP / initial change in
AD

Question 5

Multiplier formula

Answer 5

1 / MPS

Question 6

Other multiplier formulae

Answer 6

• closed Econ with no gov: k = 1/MPS
• closed Econ with gov: k= 1/(MPS + MPT)
• open Econ with gov: k = 1/MPW

Question 7

When would there be a high multiplier value?

Answer 7

• lots of spare capacity
• low propensity to import and tax
• high MPC

Question 8

When would there be a low multiplier value?

Answer 8

• economy close to full capacity
• rising demand causes inflation
• higher inflation causes rising interest rates

Question 9

Main factor in determining size of multiplier

Answer 9

The size of the withdrawals from the circular flow

Question 10

Eval of multiplier

Answer 10

• hard to measure
• Time lag
• economists disagree over it’s size
• LR multiplier effect is likely to be higher for developing countries as infrastructure projects often have higher MEs