MULTIPLIER EFFECT
Friday, 19 February 2021
The Multiplier Effect
◦ The multiplier shows how an increase in spending (injection)
produces a more than proportional increase in national income.
◦ Properties:
1. Must be > 1 (because you divide by a number 0 < x < 1)
2. It works in opposite directions
◦ The multiplier is derived from the mpc
→ The Marginal Propensity to Consume (mpc) = how much of
every extra Rand of national income will be used for
consumption as opposed to saving
→The Marginal Propensity to Save (mps) = how much of every
extra Rand of national income will be saved
The multiplier in a 2-sector model
◦ The size of the multiplier depends on the proportion of any
increase in income that is spent.
◦ The larger the mpc, the bigger the multiplier (positive relationship)
◦ The smaller the mpc, the smaller the multiplier
◦ It is the money that stays in the economy
◦ For every R1 injected, some percentage will be spent and some
will be saved, e.g.
◦ Y = R 100 000
◦ C = R 60 000
(60% is consumed)
→ mpc = 0,6
◦ S = R 40 000
(40% is saved)
→ mps = 0,4
mpc and mps relationship and formulas
◦ mpc + mps = 1
◦ The money can only be used in these two ways, so the propensities
will add up to one.
◦ This implies:
◦ mps = 1 – mpc
◦ mpc = 1 – mps
◦α=
1
1 −𝑚𝑝𝑐
=
1
𝑚𝑝𝑠
◦ E.g. mpc = 0,6 and mps = 0,4, then
◦α=
1
1 −𝑚𝑝𝑐
=
1
𝑚𝑝𝑠
=
1
1−0,6
=
1
0,4
=
2,5
Aggregate
Spending
in billions (AE)
Y = Income
E = Equilibrium
•
Scale line where AE = Y
•
AE = C + I + G
(Aggregate Expenditure)
AE1 = C + I + G •
•
E at AE = R40, Y = R100
AE = Y
E1
∆E
R 50
∆I/∆G
∆Y
AE = C + I + G
E
R 40
∆Y
∆I or ∆G →
Total expenditure
changes with same
amount as ∆I or ∆G
•
AE shifts to AE1 with ∆
•
The multiplier causes
Y → Y1 (R100 → R125)
•
E1 at AE = R50, Y = R250
•
∆Y
K = multiplier = ∆E =
gradient of AE =
45°
R 100
R 125
Total Income (Y)
R125−R100
R25
=
= 2,5
R10
R50−R40