MPC, MPS, and
Multipliers
Special thanks to Mr. David Mayer
& Mr. Ken Norman from whom I
adapted this power point
• Any increase in spending will result in an
even larger increase in GDP due to the
fact that every dollar spent is spent again
multiple times.
• Any money spent is someone else’s
income and therefore subject to spending.
• The limiting factor is savings.
• For every additional dollar spent a portion
of it will be saved (the MPS).
• The multiplier is the reciprocal of the MPS
or 1/MPS.
• The larger the MPC (the smaller the MPS)
the larger the multiplier will be.
Spending Multiplier = 1/MPS
MPC
.90
.80
.75
.60
.50
1/MPS
1/.10
1/.20
1/.25
1/.40
1/.50
= M
= 10
=
5
=
4
= 2.5
=
2
The First Round of Government
Spending Causes The Biggest Splash
MPC of 75%
G spends $200 billion on the highways.
Highway workers save 25% of $200 billion [$50
billion] & spend 75% or $150 billion on boats.
Boat makers save 25% of $150 bil. [$37.50 bil.]
& spend 75% or $112.50 bil. on iPod Minis, etc.
Total Saving has reached $87.50
• A change in taxes also has a
multiplied effect, but the tax
multiplier is smaller than the
spending multiplier.
• Tax Multiplier (note: it’s negative
because tax increases reduce
spending)
-MPC/
or MPC/
1-MPC
MPS
• If there is a tax-CUT, then the
multiplier is +, because there is now
more money in the circular flow
Tax Multiplier = -MPC/MPS
MPC
.90
.80
.75
.60
.50
= M
-MPC/.10=
-9
-MPC/.20=
-4
-MPC/.25=
-3
-MPC/.40= -1.5
-MPC/.50=
-1
MPC/MPS
Spending Multiplier
= 1/MPS
Tax Multiplier = MPC/MPS
Tax Multiplier
Multiplier
MPC
.9
-9
10
.8
5
.75
4 -3
-4
.60 2.5 -1.5
.5
2 -1
The larger the MPC, the smaller the MPS, and the
greater the multiplier. This is the “simple multiplier”
because it is based on a “simple model of the economy”.
OU
USING MULTIPLIERS
• The multiplier can be used to calculate
how any change in spending will affect
total spending (AD)/income (GDP).
• The formula used is: Change in
Spending x Multiplier = Change in AD.
USING MULTIPLIERS
• Since any change in GDP is the result of
the change in spending x multiplier, you
can find the multiplier by dividing the
change in AD/GDP by the change in
spending.
USING MULTIPLIERS
• Knowing that any change in spending will
have a multiplied effect government can
calculate how much to change spending
by dividing the needed change in GDP
by the multiplier.
Multiplier Practice
• Assume US citizens spend $.90 for every
extra $1 they earn.
• Further assume that the real interest rate
(i) decreases, causing a $50 billion
increase in Investment (I).
• Calculate the effect of this increase in
spending on AD.
Step 1: Calculate the MPC and MPS
MPC = C / DI
MPS = 1- MPC =
Step 2: Determine which multiplier to use, and
whether its + or –
The problem mentions an increase in I, use a (+)
spending multiplier
Step 3: Calculate the Spending and/or Tax
Multiplier
Step 4: Calculate the Change in AD
(
C, I, G or NX) * Spending or Tax Multiplier
More Practice
• Assume Germany raises taxes on its
citizens by 200b.
• Assume that Germans save 25% of the
change in their disposable income.
• Calculate the effect of these taxes on the
German economy.
More Practice
• Assume the Japanese spend 4/5 of their
disposable income.
• Assume that the Japanese government
increases its spending by 50 trillion and
in order to maintain a balanced budget
simultaneously increase taxes by 50t.
• Calculate the effect of these changes on
the Japanese Aggregate Demand.
The Balanced Budget Multiplier
• When government spending increases are
matched with equal size increases in taxes,
the change ends up being = to the change
in government spending
• Why?
•
1/
-MPC/
1- MPC/
MPS/
+
=
=
MPS
MPS
MPS
MPS = 1
• The balanced budget multiplier always = 1