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Multiplier

Multiplier. Summary. The Multiplier. The Multiplier : -- The multiple by which an initial change in spending will alter total expenditure after an infinite number of spending cycles; .

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Multiplier

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  1. Multiplier Summary

  2. The Multiplier The Multiplier:-- The multiple by which an initial change in spending will alter total expenditure after an infinite number of spending cycles; • An increase in spending by one party increases the income of others. Thus, an increase in spending can expand output by a much larger amount. • The multiplier is the number by which the initial change in spending is multiplied to obtain the total amplified increase in income. • The size of the multiplier increases with the marginal propensity to consume (MPC).

  3. In evaluating the importance of the multiplier, one should remember: The Multiplier • taxes and spending on imports will dampen the size of the multiplier; • it takes time for the multiplier to work; and, • the amplified effect on real output will be valid only when the additional spending brings idle resources into production without price changes.

  4. Multiplier Formula Multiplier is ______1_____ 1 – MPC When money is spent by someone, it becomes someone else’s income. When someone spends adollar, perhaps someone who received that dollar would spend 80 cents..next person would spend 64 cents…If you add up the spending created by that one dollar, it will add up to four or five times that dollar… hence “the multiplier”

  5. The multiplier principle applies in reverse also. (decrease, yields reduction) (money in shoe box) Marginal Propensity to Consume is the key The multiplier builds on the principle that one individual’s expenditure becomes the income of another. *Income increases- we spend some on “more stuff” In turn consumption expenditures on “stuff” will generate additional income for others who will spend part of their income on “stuff” also. There is a direct correlation between expenditure multiplier and MPC.

  6. The Multiplier Process 3. Income reduced by $100 billion 4. Consumption reduced by $75 billion Households 7. Income reduced by $75 billion more 8. Consumption reduced by $56.25 billion more Factor markets Product markets 9. And so on 6. Further cutbacks in employment or wages 5. Sales fall $75 billion Business firms 2. Cutbacks in employment or wages 1. $100 billion in unsold goods appear

  7. Marginal Propensity To Consume AdditionalIncome(Dollars) AdditionalConsumption(Dollars) ExpenditureStage Round 1 3/4 Round 2 3/4 Round 3 3/4 Round 4 3/4 Round 5 3/4 Round 6 3/4 Round 7 3/4 Round 8 3/4 Round 9 3/4 Round 10 3/4 3/4 All Others Total 4,000,000 3,000,000 3/4 For simplicity (here) it is assumed that all additions to income are either spent domestically or saved. The Multiplier Principle 1,000,000 750,000 750,000 562,500 562,500 421,875 421,875 316,406 316,406 237,305 237,305 177,979 177,979 133,484 133,484 100,113 100,113 75,085 75,085 56,314 225,253 168,939 • The multiplier concept is fundamentally based upon the proportion of additional income that households choose to spend on consumption: the marginal propensity to consume (here assumed to be 75%  3/4).

  8. Multiplier EffectsKeynesian theory C = $300 billion I = $100 billion Price Level (average price) Real Output (in billions of dollars per year) AS m d a P0 b AD0 c AD1 AD2 2600 2800 QF

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