The Multiplier Effect Small change in investment leads to a large change in output and income. The multiplier determines how large the change will be Multiplier = change in GDPr / initial change in spending Ex. A $5 billion change in Ig led to a $20 billion change in GDP. What is the multiplier? 4444
Rationale The economy has continuous flows of expenditure & income—ripple effect Income received by person A comes from $ spent from person B. Change in income will cause both C and S to vary in the same direction as the initial change in income (increase or decease) and by a fraction of that change.
Rationale continued The fraction of the change in income that is spent is called the MPC The fraction of the change in income that is saved is called the MPS
Multiplier & Marginal Propensities The size of the MPC and the multiplier are directly related The size of the MPS & the multiplier are inversely related M = 1 / MPS or M = 1 / (1-MPC)
Significance of the Multiplier A small change in investment plans or consumption savings plans can trigger a much larger change in the equilibrium level of GDP
Generalizing the Multiplier We have seen the simple multiplier The multiplier can be generalized to include other “leakages” from the spending flow besides savings Realistic multiplier includes taxes and imports