3.2: Multipliers

Question 1

The Multiplier Effect

Answer 1

shows how spending is magnified in the economy.

Question 2

If gov. spends $5 million, will AD increase the same amount?

Answer 2

No, gov. spending becomes someone else’s income. Consumers take the money and spend it increasing AD.

Question 3

Marginal Prosperity to Consume (MPC)

Answer 3

how much people consume rather than save, when there is a change in disposable income.

Always expressed as a fraction(decimal)

MPC: Change in consumption/change in disposable income

Question 4

Marginal Prosperity to Save (MPS)

Answer 4

How much people save rather than consume when change in disposable income

Always expressed as fraction(decimal)

MPS: Change in Savings/Change in Disposable Income

MPC + MPS = 1

Question 5

Calculating the Spending Multiplier

Answer 5

Total Change in GDP= Multiplier * Initial Change in Spending

Spending Multiplier= 1/ MPS or 1/1-MPC

Question 6

Does the multiplier effect also apply w/ gov. cuts or increases taxes

Answer 6

Yes, but changing taxes has less of an impact than gov. spending

Question 7

Calculating the Tax Multiper

Answer 7

Simple Tax Multiplier: MPC * 1/MPS or MPC/MPS

If the spending multiplier is 4, the the tax multiplier is only 3.

Remember: an increase in taxes decreases GDP so the tax multiplier is negative

Total change in GDP= Tax Multiplier * Initial Change in Taxes