The Multiplier

Question 1

What is the multiplier ratio

Answer 1

The multiplier ratio is the ratio of change in real income to the injection that created the change
E.g. If the UK government injected an additional £5m into the economy through government spending and it resulted in an increase in real income of £15m, the value of the multiplier would be 3

Question 2

What is the multiplier process?

Answer 2

The multiplier process is based on the idea that one individual’s spending is another individual’s income
An increase in consumption immediately increases AD
Store owners who have benefitted from the extra consumption now have extra income
They spend some of that income on goods/services
Their expenditure on goods/services is now income for the next tier of individuals

Due to the successive rounds of spending, the final increase in national income is much larger than the initial injection

Question 3

What does the size of the multiplied depend on?

Answer 3

The size of the multiplier is entirely dependent on the size of leakages that occur during the process
The higher the leakages the smaller the multiplier

Question 4

What does the initial injection do?

Answer 4

The initial injection shifts AD to the right
The result of the multiplier process is that there is then a secondary movement of AD to the right which (if the multiplier were 2) may be double the initial movement

Question 5

What is the downward multiplier effect?

Answer 5

The multiplier can also work in reverse when injections are reduced (downward multiplier effect)

Question 6

What are marginal propensities?

Answer 6

The ‘marginal propensities’ refer to the proportion of the next $ earned that a consumer saves, consumes, is taxed, or purchases imports with
Marginal propensities are calculated for economies and provide insights into how each additional $ of income is allocated
Sweden has a higher tendency to save than the USA
Their marginal propensity to save is higher
The USA, therefore, has a greater multiplier on any injections into the Circular Flow

Question 7

What is MPC?

Answer 7

Marginal propensity to consume

The proportion of additional income that is spent

Question 8

What is MPS?

Answer 8

Marginal propensity to save

The proportion of additional income that is saved

Question 9

What is MPT?

Answer 9

Marginal propensity to tax

The proportion of additional income that is paid in tax

Question 10

What is MPM?

Answer 10

Marginal propensity to import

The proportion of additional income that is spent on imports

Question 11

What are the two ways you can calculate the value of the multiplier?

Answer 11

By focusing on the marginal propensity to consume (MPC)
By focusing on the withdrawals that occur on each additional $ of income (MPS + MPT + MPM)

Question 12

Give the 2 formulas to calculate the multiplier

Answer 12

1/ 1- MPC

1/MPW = 1/ (MPM+MPS+MPT)

Question 13

Relationship between withdrawals and the value of the multiplier

Answer 13

The greater the withdrawals, the smaller the value of the multiplier - and vice versa

Question 14

Relationship between MPC and value of multiplier

Answer 14

The greater the MPC, the greater the value of the multiplier - and vice versa

Question 15

What factors change the multiplier?

Answer 15

Any change in one of the factors that impacts on disposable income, will change the multiplier
If taxes increase the value of the multiplier reduces
If interest rates increase, savings increase and consumption decreases and the multiplier reduces
If exchange rates appreciate the level of imports will increase and the multiplier decreases
If confidence in the economy increases consumption increases and the multiplier increases

Question 16

Why is it useful for the government to know the value of the multiplier?

Answer 16

They can use it to judge the likely economic growth caused by increased spending

Question 17

Evaluation point for the multiplier

Answer 17

There is a time lag as it takes time for the successive rounds of income to work through the economy

It may take up to 18 months for the full multiplier effect to be seen & any change to consumer confidence during this period will impact the final outcome.