What is the multiplier effect?

What relationship does the MPC bear to the size of the multiplier? The MPS? What will the multiplier be when the mps is 0.4, 0.6? When the MPS is 1, 1/2 and 0? HOw much of a change in the economy will result if business's increase their level of investment by 8 billion and the MPC in the economy is 4/5? If the MPC is 2/3?

Relevance

In economics, the multiplier effect refers to the idea that an initial spending rise can lead to an even greater increase in national income. In other words, an initial change in aggregate demand can cause a further change in aggregate output for the economy.

The multiplier effect is a tool used by governments to restimulate aggregate demand. This can be done in a period of recession or economic uncertainty. The money invested by a government creates more jobs, which in turn will mean more spending and so on.

For example: a company spends $1 million to build a factory. The money does not disappear, but rather becomes wages to builders, revenue to suppliers etc. The builders will have higher disposable income as a result, so consumption, hence aggregate demand will rise as well. Say that all of these workers combined spend$2 million dollars in total, since there was an initial $1 million input which created a$2 million output, the multiplier is 2.

Another example is when a tourist visits somewhere they need to buy the plane ticket, catch a taxi from the airport to the hotel, book in at the hotel, eat at the restaurant and go to the movies or tourist destination. The taxi driver needs petrol for his cab, the hotel needs to hire the staff, the restaurant needs attendants and chefs, and the movies and tourist destinations need staff and cleaners.

It must be noted that the extent of the multiplier effect is dependent upon the marginal propensity to consume and marginal propensity to import. Also that the multiplier can work in reverse as well, so an initial fall in spending can trigger further falls in aggregate output.

The basic formula for the economic multiplier, in macroeconomics, is \Delta Y \over \Delta I, or the change in equilibrium GDP divided by the change in investment (i.e. the initial increase in spending).

It is particularly associated with Keynesian economics; some other schools of economic thought reject, or downplay the importance of multiplier effects, particularly in the long run. The multiplier has been used as an argument for government spending or taxation relief to stimulate aggregate demand.

The concept of the economic multiplier on a macroeconomic scale can be extended to any economic region. For example, building a new factory may lead to new employment for locals, which may have knock-on economic effects for the city or region.

In economics, the multiplier effect refers to the idea that an initial spending rise can lead to an even greater increase in national income. In other words, an initial change in aggregate demand can cause a further change in aggregate output for the economy.

For example: a company spends $1 million to build a factory. The money does not disappear, but rather becomes wages to builders, revenue to suppliers etc. The builders will have higher disposable income as a result, so consumption, hence aggregate demand will rise as well. Say that all of these workers combined spend$2 million dollars in total, since there was an initial $1 million input which created a$2 million output, the multiplier is 2.

Another example is when a tourist visits somewhere they need to buy the plane ticket, catch a taxi from the airport to the hotel, book in at the hotel, eat at the restaurant and go to the movies or tourist destination. The taxi driver needs petrol for his cab, the hotel needs to hire the staff, the restaurant needs attendants and chefs, and the movies and tourist destinations need staff and cleaners.

It must be noted that the extent of the multiplier effect is dependent upon the marginal propensity to consume and marginal propensity to import. Also that the multiplier can work in reverse as well, so an initial fall in spending can trigger further falls in aggregate output.

It is particularly associated with Keynesian economics; some other schools of economic thought reject, or downplay the importance of multiplier effects, particularly in the long run. The multiplier has been used as an argument for government spending or taxation relief to stimulate aggregate demand.

The concept of the economic multiplier on a macroeconomic scale can be extended to any economic region. For example, building a new factory may lead to new employment for locals, which may have knock-on economic effects for the city or region.

• 4 years ago

Multiplier Effect

MPC is part of multiplier calculation.

MPS stand for marginal propensity to save. MPS=1-MPC

It actually depends on which multiplier you are referring to.

For simplest case it will be:

ΔY/ΔG=1/(1-MPC)=1/MPS

So, MPS=0.4 multiplier=1/0.4=2.5

MPS=0.6 multiplier=1/0.6=5/3

MPS=1 multiplier=1/1=1

MPS=1/2 multiplier=2

MPS=0 multiplier=&inf;

MPC=4/5 MPS=1/5 ΔI=8

ΔY/ΔI=5

ΔY=8*5=40

MPC=2/3 MPS=1/3 ΔI=8

ΔY/ΔI=3

ΔY=8*3=24