The multiplier

Question 1

What is the multiplier

Answer 1

A numerical coefficient multiplied to a change in autonomous spending (ie changes to C, I, G, X) to show the final change in equilibrium national income

Question 2

What is the multiplier principle

Answer 2

A change in autonomous spending will lead to a more than proportionate change in RNY

Example:
An initial increase in autonomous AD (due to an increase in any of the components of AD) will lead to a more than proportionate increase in RNY; assuming there is sufficient spare capacity.

Conversely, an initial decrease in autonomous AD will lead to a more than proportionate decrease in RNY.

Question 3

What are the conditions for the multiplier to work

Answer 3

1. The economy is operating along the Keynesian range of the AS curve where there is no capacity constraints and no change in the GPL
2. There is a constant state of technology
3. Absence of time lags

The multiplier process ends when the initial increase in autonomous AD has totally leaked out as withdrawals (taxes, import expenditure, savings)

Question 4

Why must these conditions be fulfilled

Question 5

What is the Keynesian multiplier formula

Answer 5

The multiplier takes on the coefficient, k and follows the formula:

k = 1/MPW (marginal propensity to withdraw)

MPW is the sum of MPS, MPT and MPM

MPW is also [1 - MPC] on domestically produced g/s (marginal propensity to consume)

Question 6

What is the real world multiplier (k) formula

Answer 6

k = change in NY/change in AD

change in NY is the change in equilibrium national income

change in AD is the change in total spending/expenditure

Question 7

What is the MPW

Answer 7

Marginal propensity to withdraw

This represents the additional proportion of individuals or households choose to take out from the economy through savings (MPS), taxes (MPT), or imports (MPM) ie leakages of the economy rather than the consumption of domestic g/s

Question 8

What is MPC, MPS, MPT, MPM

Answer 8

MPC: marginal propensity to consume (change in expenditure on domestic g/s in response to change in national income)

MPS: marginal propensity to save (change in savings in response to change in national income)

MPT: marginal propensity to tax (change in tax paid to change in national income)

MPM: marginal propensity to import (change in import expenditure in response to change in national income)

Question 9

What is the relationship between the multiplier and MPC & MPW

Answer 9

There is a direct relationship between the multiplier and MPC

There is an indirect relationship between the multiplier and MPW

Question 10

How does the multiplier work with the AD-AS approach or circular flow of income

Answer 10

A process is created whereby expenditure generates income cycles of spending and re=spending which causes a more than proportionate shift in the AD curve with respect to injections into the economy.

Question 11

What are the limitations of the multiplier effect

Answer 11

1. Over/understated size/value of k
   - Varying levels of MPW due to the nature of savings, taxes or imports can result in varying levels of the value of k
   - This may not accurately reflect the proportion of change in AD values which may not accurately reflect the change in RNY for a given change in AD
2. Level of spare capacity in the economy
   - The degree of access capacity of FoPs a country has will allow the multiplier effect to take effect to full extent or can be diminished.
   - An economy with abundant access to idle resources can increase additional output significantly without the concern of rising additional unit cost of production.
   - As price is held constant, a rightward shift in the AD curve along the horizontal part of the AS curve will allow the multiplier effect to be fully experienced.

• An economy with constraints/scare access to spare capacity, ie moving closer to its maximum productive capacity due to supply bottlenecks will find it difficult to expand output.
• However, there is competition over these scare g/s and general prices increase to beat out other consumers. Due to the rising prices, firms will be profit incentivised to increase output despite constraints.
• The increase in GPL reduces the level of consumption by households due to the wealth, i/r, and int. subs effect. The increase in the GPL will have a dampening effect on the extent of the multiplier effect. Hence, RNY will increase to a lesser extent due to the dampened extent of the multiplier effect.

3. Time lags
   - The multiplier takes time to work and changes to RNY/output will only be observed over prolong periods of time.
4. Difficulties in measurement
   - It is difficult to precisely measure the MPM, MPS and MPT. These values are not the same as the aggregate savings or import expenditure of the economy. At times, either one of the MPM, MPS, or the MPT is often not available, making calculation of the size of the multiplier difficult.