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Importance of the Multiplier Effect: Simplified Explanation

Understand the concept of the multiplier effect through a sequence of exchanges with Robin Hood's donations. Learn how the MPC affects the multiplier and income increases. Discover how to calculate the multiplier and simulate different scenarios. See the algebraic formula for fast calculations and grasp the significance of the MPC in determining income growth.

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Importance of the Multiplier Effect: Simplified Explanation

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  1. IMPORTANCE of the MULTILPIER SIMPLIFIED

  2. MULTIPLIER • Sequence of exchanges that would occur • FOLLOW THE SEQUENCE OF EVENTS • ROBIN HOOD DONATED $1,000 TO EACH STUDENT • EACH STUDENT HAS AN MPC OF .8

  3. How much would you spend, given an MPC of .8

  4. $1,000 x .8 =$800

  5. MULTIPLIER $1,000 x .8 =$800

  6. MULTIPLIER $800 x .8 =$640

  7. MULTIPLIER $800 x .8 =$640

  8. MULTIPLIER $640 x .8 =$512

  9. MULTIPLIER $640 x .8 =$512

  10. MULTIPLIER $512 x .8 =$409.6

  11. MULTIPLIER $512 x .8 =$409.6

  12. MULTIPLIER $409.6 x .8 =$327.68

  13. MULTIPLIER $409.6 x .8 =$327.68

  14. MULTIPLIER $327.6 8x .8 =$262.14

  15. MULTIPLIER $327.6 8x .8 =$262.14 (3951.42)

  16. MULTIPLIER • SEQUENTIALLY THIS WILL GO ON UNTIL THE ADDITIONS TO INCOME AND THE ADDITIONS TO CONSUMPTION BOTH APPROACH ZERO • THE SUMS FOR INCOME AND CONSUMPTION APPREAR TO BE APPROACHING SPECIFIC NUMBERS • INCOME INCREASES GREATER THAN CONSUMPTION INCREASES

  17. MULTIPLIER • INCOME INCREASES GREATER THAN CONSUMPTION INCREASES BY AN AMOUNT EQUAL TO THE NEW INCOME ($1,000) INITIALLY INTRODUCED BY ROBIN HOOD TO EACH STUDENT • INCOME AND CONSUMPTION BOTH INCREASE BY A MULTIPLE OF THE ORIGINAL CHANGE IN INCOME

  18. MULTIPLIER • THE MPC IS IMPORTANT BECAUSE IT DETERMINES THE SIZE OF THE MULTIPLIER, WHICH DETERMINES HOW MUCH INCOME INCREASES. • RECREATE YOUR OWN MULTIPLIER USING AN MPC OF .9 AND THEN MPC 0F .5

  19. MULTIPLIER • SIMPLE MULTIPLIER WORKS SIMILARLY ON ANY CHANGE IN NEW SPENDING WHETHER INITIATED BY CONSUMERS, BUSINESSES OR GOVERNMENT. • THE CHANGE IN SPENDING, MUST BE AUTONOMOUS

  20. MULTIPLIER • AN ALGEBRAIC FORMULA HAS BEEN DEVELOPED THAT PERMITS MUCH QUICKER CALCULATION FOR THE AMOUNT BY WHICH TOTAL INCOME CHANGES WHEN SOMEONE INJECTS NEW SPENDING INTO THE ECONOMY. • THE FORMULA—CALLED THE MULTIPLIER • MULTIPLIER=1/(1-MPC)

  21. FORMULA • ALGEBRAICALLY THE MULTIPLIER YIELDS THE SAME CHANGE IN TOTAL INCOME: • MPC OF .8 • [1/(1-MPC)= • 1/(1-.8)= • 1/.2= • 10/2X$1,000= • $5,000

  22. FORMULA • ALGEBRAICALLY THE MULTIPLIER YIELDS THE SAME CHANGE IN TOTAL INCOME: • MPC OF .9 • [1/(1-MPC)= • 1/(1-.9)= • 1/.1= • 10/1X$1,000= • $10,000

  23. FORMULA • ALGEBRAICALLY THE MULTIPLIER YIELDS THE SAME CHANGE IN TOTAL INCOME: • MPC OF .5 • [1/(1-MPC)= • 1/(1-.5)= • 1/.5= • 2/1X$1,000= • $2,000

  24. CHANGE UP • REMEMBER THAT MPC+MPS=1 • THEREFORE, 1-MPC=MPS • WE CAN REPLACE EACH DENOMINATOR ABOVE WITH MPS • THIS ALLOWS US TO EXPRESS THE MULTIPLIER ALSO IN TERMS OF THE SAVINGS BEHAVIOR OF CONSUMERS • MULTIPLIER = 1/MPS

  25. FORMULA • FOR PRACTICE : • MPS OF .2, .1 AND .5

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