The multiplier effect

Question 1

What is the Multiplier effect?

Answer 1

• When there is an initial injection into the economy, it will result in a more than proportional increase in national income, due to the multiplier effect.

Question 2

What does the Multiplier effect lead to?

Answer 2

• Stimulates further rounds of spending leading to a bigger eventual effect on output and employment as the money is circulated around the economy.

Question 3

What is the size of the multiplier based on?

Answer 3

• How much of an extra pounds injected will be re-spent in the economy (the MPC).
• Any money not re-spent is ‘leaked’ (withdrawn).

Question 4

What is the formula of MPC?

Answer 4

• Change in consumption divided by the change in income.

Question 5

What is the correlation between the multiplier and the effect on the economy of an injection?

Answer 5

• Larger the multiplier would lead to a bigger effect on the economy of an injection.

Question 6

What is the relationship between withdrawals and the size of the multiplier?

Answer 6

• The higher the leakages (withdrawals), the smaller the size of the multiplier.

Question 7

What are leakages?

Answer 7

• Savings.
• Taxes.
• Imports.

Question 8

What is the MPS?

Answer 8

• Marginal propensity to save. Measures proportion of an increase in income that is saved.

Question 9

What is the MPT?

Answer 9

• Marginal propensity to tax.
• Measures the proportion of an increase in income taken in tax.

Question 10

What is the MPM?

Answer 10

• Marginal propensity to Import.
• The proportion of an increase in income that is spent on imports.

Question 11

What is the formula for the total proportion of an increase in income that is withdrawn?

Answer 11

• MPW = MPS + MPT + MPM

Question 12

What are the two ways to calculate the multiplier?

Answer 12

• 1 over (1 - MPC)
• This is equal to 1 over (MPS + MPT + MPM)

Or: 1/MPW

Question 13

What are the factors affecting the size of the multiplier?

Answer 13

• Interest rates
• Tax rates
• Imports
• Spare capacity
• Confidence
• Income levels

Question 14

What does a positive multiplier lead to?

Answer 14

• An initial decrease in an injection or decrease in leakage, will lead to an even greater overall increase in national income.

Question 15

What does a negative multiplier lead to?

Answer 15

• An initial decrease in an injection or increase in a leakage in the economy will lead to an even greater overall decrease in national income.

Question 16

How do interest rates affect the size of the multiplier?

Answer 16

• If rates are high, then consumption may not rise significantly as additional income would be saved.
• This would motivate for more saving and therefore more withdrawals from the circular flow of income.

Question 17

How do Tax rates affect the size of the multiplier?

Answer 17

• Taxes are a withdrawal from the circular flow, and if taxes are high, consumers would have less disposable income to consume goods and services, so injections would not increase national income as anticipated.

Question 18

How do Imports affect the size of the multiplier?

Answer 18

• In the UK, we have a high propensity to consume imports.
• If we receive increases in disposable income, but it is spent on imported goods, then this would count as a withdrawal and national income would not rise as much as anticipated.

Question 19

How does spare capacity affect the size of the multiplier?

Answer 19

• If there are low factors of production, then any increase in aggregate demand may not be able to be met by firms. This is true in the short run.
• The multiplier would therefore be limited as the injection of cash may not actually be translated into more output.

Question 20

How does Confidence affect the size of the multiplier?

Answer 20

• If confidence is high, people may be encouraged to spend but if people are worried about job prospects or an economic slump, the MPC is likely to fall.

Question 21

How does Income levels affect the size of the multiplier?

Answer 21

• If individuals have low incomes, then any increase in income is likely to be spent; these people tend to have a high MPC.
• If an individual is on a higher income, they may already have brought everything they need, so are more likely on average to save.