Multiplier Effect

Test yourself

Marginal Propensities

Different marginal propensities are important for working out how big the multiplier effect in an economy.

Marginal propensity to consume (MPC)

The marginal propensity to consume (MPC) is calculated as the change in C divided by change in income.
The MPC represents the amount of each extra pound that the consumer spends when given an extra pound in income.
If the MPC was 0.25, this means that for each extra pound in income, they spend £0.25.
People who earn less money or live in poorer countries usually have higher MPCs.

Marginal propensity to save (MPS)

The marginal propensity to save (MPS) is calculated as the change in savings divided by change in income.
The MPS represents the amount of each extra pound that the consumer saves when given an extra pound in income.

Marginal propensity to tax (MPT)

The marginal propensity to tax (MPT) is the change in tax paid divided by the change in income.
The MPT represents the amount of each extra pound earned that is spent paying taxes.
The MPT can also be called the marginal tax rate.

Marginal propensity to import (MPM)

The marginal propensity to import (MPM) is the change in imports purchased divided by the change in income.
For every extra £1 of income, the MPM is the proportion of that £1 spent on imported goods.

Multiplier Effect

The multiplier is defined as an initial change in an injection or leakage that leads to a much greater final change in real national income. One person’s consumption is another person’s income.

How the multiplier works

Let's say a government decides to build a new hospital at a cost of £50 billion.
Government spending (G) will rise by £50bn. AD and real GDP will rise by £50bn.
The government will spend £25bn of this money on a construction firm. The firm spends £10bn on investment (I), a component of AD. Investment rises by £10bn.

How the multiplier works cont.

The firm also spends £5bn on workers who receive higher incomes and spend this – so now consumer spending (C) goes up by £5bn. C is another component of AD.
AD has risen £65bn (£50bn plus £10bn plus £5bn) from an initial £50bn.
So, if spending rises by an initial £50bn, there will be one large rightwards shift in AD. But each stage of the multiplier effect could be viewed to add another small rightwards shift in AD, each of a smaller size than the last.

Marginal propensity to consume

The marginal propensity to consume (MPC) is calculated as change in C divided by change in income.
The MPC represents the amount of each extra pound that the consumer spends when given an extra pound in income.
If the MPC was 0.25, this means that for each extra pound in income, they spend £0.25.
The higher the MPC, the higher the multiplier – it means more money is passed on at each “stage”.
So if taxes rise, then more money is leaked. So the MPC must fall, and the multiplier falls.

Calculating the multiplier

Because some money will be leaked, eventually less and less is passed on. So if we add up all the stages, we can come up with a total increase.
To calculate this, we can use the following formula:
- Multiplier = $\frac{1}{(1 - MPC)}$
- E.g. If MPC = 0.2:
- Multiplier = $\frac{1}{(1 - 0.2)}$
- Multiplier = $\frac{1}{0.8}$ = 1.25
An initial injection of £10bn will result in £12.5bn increase in real national income.

The Multiplier Effect visually

Marginal propensity to consume in real life

Japelli (1990) found that 20% of the American population was credit-constrained.
Gross & Souleles (2002) found that 2/3 of people responded to automatic increases in their credit card limits by spending more.
Both these studies suggest that the MPC may be high and that the availability of credit (or debt) could be the constraining factor.

Marginal Propensity to Withdraw

The marginal propensity to withdraw = MPS + MPT + MPM. Savings, taxes, and imports from abroad are all 'withdrawals' from the economy. Extra earnings are either spent consuming goods or are withdrawn. MPC + MPW = 1. So the Multiplier effect also equals 1/MPW.

Marginal propensity to withdraw

The marginal propensity to withdraw is the proportion of additional earnings that are taken out of the economy via savings, taxes paid to the government or imports from abroad.
The marginal propensity to withdraw = MPS + MPT + MPM.

Marginal propensity to save

The MPS is the portion of extra income that is saved by an individual.
Savings are a withdrawal and cannot be spent on consumption.
A higher MPS will increase the MPW and reduce the size of the multiplier in the economy.

Marginal propensity to tax

The MPT is the portion of extra income that is spent by an individual paying taxes to the government.
Taxes are a withdrawal and cannot be spent on consumption.
A higher MPT will increase the MPW and reduce the size of the multiplier in the economy.

Marginal propensity to import

The MPM is the portion of extra income that is spent by an individual paying for imports from overseas.
Imports are a withdrawal and cannot be spent on consumption.
A higher MPM will increase the MPW and reduce the size of the multiplier in the economy.

1Introduction to Markets

2Market Failure

2.1Market Failure

2.1.1Types of Market Failure

2.1.2Externalities

2.1.3The Deadweight Welfare Loss of Externalities

2.1.4A-A* (AO3/4) - The Externalities of Education

2.1.5Public Goods

2.1.6Information Gaps

2.1.7End of Topic Test - Market Failure

2.1.8Application Questions - Market Failure

2.2Government Intervention

2.2.1Government Intervention in Markets

2.2.2Subsidies & Price Controls

2.2.3Pollution Permits & Regulation

2.2.4A-A* (AO3/4) - European Emissions Trading

2.2.5State Provision & Information Provision

2.2.6Government Failure

2.2.7End of Topic Test - Government Intervention

2.2.8A-A* (AO3/4) - Government Intervention

3The UK Macroeconomy

3.1Measures of Economic Performance

3.1.1Measuring Economic Growth

3.1.2National Income Data

3.1.3Inflation

3.1.4Causes of Inflation

3.1.5Consequences of Inflation

3.1.6Employment & Unemployment

3.1.7Causes & Impact of Unemployment

3.1.8A-A* (AO3/4) - Hysteresis

3.1.9Balance of Payments

3.1.10Current Account Deficit & Imbalances

3.1.11End of Topic Test - Economic Performance

3.1.12Application Questions Macroeconomy

3.2Aggregate Demand

3.2.1Aggregate Demand

3.2.2Consumption

3.2.3Investment

3.2.4Government Expenditure

3.2.5Net Trade

3.2.6End of Topic Test - Aggregated Demand

3.2.7Application Questions - AD

3.3Aggregate Supply

3.3.1Aggregate Supply

3.3.2End of Topic Test - Aggregated Supply

3.3.3A-A* (AO3/4) -Aggregate Supply

3.4National Income

3.4.1National Income

3.4.2Injections & Withdrawals

3.4.3Equilibrium Level of Real National Output

3.4.4Multiplier Effect

3.4.5End of Topic Test - National Income

3.4.6Application Questions - National Income

3.5Economic Growth

3.5.1Causes of Economic Growth

3.5.2Output Gaps

3.5.3Business Cycle

3.5.4Impact of Economic Growth

3.5.5End of Topic Test - Economic Growth

3.5.6A-A* (AO3/4) - Growth

4The UK Economy - Policies

4.1Macroeconomic Objectives & Policies

4.1.1Possible Objectives

4.1.2Demand-Side Policies - Monetary

4.1.3Demand-Side Policies - Monetary 2

4.1.4A-A* (AO3/4) - The Future of Interest Rates

4.1.5Demand-Side Policies - Fiscal

4.1.6Demand-Side Policies in 2007-08

4.1.7Strengths & Weaknesses of Demand Side

4.1.8Supply-Side Policies

4.1.9Supply-Side Policies 2

4.1.10Conflicts Between Objectives

4.1.11A-A* (AO3/4) - Conflicting Incentives

4.1.12Phillips Curve

4.1.13End of Topic Topic - Policies & Objectives

4.1.14Application Questions - UK Policies

5Business Behaviour

5.1Business Growth

5.1.1Size & Types of Firms

5.1.2Business Growth

5.1.3Pros & Cons of External Expansion

5.1.4Demergers

5.1.5End of Topic Test - Business Growth

5.1.6A-A* (AO3/4) - Business Growth

5.2Business Objectives

5.2.1Business Objectives

5.2.2End of Topic Test - Business Objectives

5.2.3Application Questions - Business Objectives

5.3Revenues, Costs & Profits

5.3.1Revenue

5.3.2Costs

5.3.3Economies & Diseconomies of Scale

5.3.4Profits

5.3.5Profits 2

5.3.6End of Topic Test - Revenue, Costs & Profits

5.3.7A-A* (AO3/4) - Revenue, Costs & Profit

6Market Structures

6.1Market Structures

6.1.1Efficiency

6.1.2Perfect Competition

6.1.3Perfect Competition 2

6.1.4Monopolistic Competition

6.1.5Oligopolies

6.1.6The Prisoner's Dilemma

6.1.7Collusion in Oligopolistic Markets

6.1.8A-A* (AO3/4) - Which Factors Affect Collusion?

6.1.9Monopolies

6.1.10Price Discrimination

6.1.11Monopsony

6.1.12A-A* (AO3/4) - Models in Economics

6.1.13Contestability

6.1.14Benefits of Contestability

6.1.15End of Topic Test - Market Structures

6.1.16Application Questions - Market Structures

6.1.17A-A* (AO3/4) - Cereal Collusion

6.2Labour Market

6.2.1Demand for Labour

6.2.2Supply of Labour

6.2.3Labour Market Imperfections

6.2.4A-A* (AO3/4) - Labour Productivity & Unemployment

6.2.5A-A* (AO3/4) - What Level of Unionisation is Good?

6.2.6Wage Determination

6.2.7Elasticity of Labour Supply & Demand

6.2.8Intervention in Setting Wages

6.2.9End of Topic Test - Labour Market

6.2.10A-A* (AO3/4) - Labour Markets

6.3Government Intervention

6.3.1Reasons for Government Intervention

6.3.2Government Promotion of Competition

6.3.3Usefulness of Competition Policy & Examples

6.3.4A-A* (AO3/4) - Modern Competition Policy

6.3.5Privatisation

6.3.6Government Regulation

6.3.7A-A* (AO3/4) - Nationalisation vs Privatisation

6.3.8Government Protection of Suppliers and Employees

6.3.9Impact of Government Intervention

6.3.10End of Topic Test - Government Intervention

6.3.11Application Questions - Government Intervention

7A Global Perspective

8Finance & Inequality

8.1Poverty & Inequality

8.1.1Absolute & Relative Poverty

8.1.2Inequality

8.1.3Inequality 2

8.1.4Lorenz Curve

8.1.5Government Policy on Poverty

8.1.6End of Topic Test - Poverty & Inequality

8.1.7A-A* (AO3/4) - Inequality & Poverty

8.2Emerging & Developing Economies

8.2.1Measures of Development

8.2.2Factors Influencing Growth & Development

8.2.3Barriers to Development

8.2.4Barriers to Development 2

8.2.5A-A* (AO3/4) - The Bottom Billion

8.2.6Development Strategies

8.2.7Interventionist Strategies

8.2.8Aid

8.2.9International Institutions

8.2.10International Institutions 2

8.2.11End of Topic Test - Emerging & Developing

8.2.12Application Questions - Developing Countries

8.3The Financial Sector

8.3.1Role of Financial Markets

8.3.2Market Failure in the Financial Sector

8.3.3Role of Central Banks

8.3.4End of Topic Test - The Financial Sector

8.3.5A-A* (AO3/4) - Financial Sector

8.4Role of the State in the Macroeconomy

8.4.1Public Expenditure

8.4.2Taxation

8.4.3Public Sector Finances

8.4.4End of Topic Test - Role of the State

8.4.5Application Questions - Role of the State

9Examples of Global Policy

9.1International Policies

9.1.1Global Debt & Deficit Policies

9.1.2Poverty & Inequality Policies

9.1.3Changes in Interest Rates

9.1.4Competitiveness Policies

9.1.5End of Topic Test - International Policies

9.1.6A-A* (AO3/4) - International Policies

9.2Policy Responses to Shocks

9.2.1International Tax Policies

9.2.2Problems for Policymakers

9.2.3End of Topic Test - Policy Responses

9.2.4Application Questions - Policy Responses

Jump to other topics