The Multiplier Effect

A change in the level of injections or withdrawals will result in a bigger or multiplied change
in the level of national income.
The size of this change will depend upon peoples desire or propensity to spend any extra
income that they receive. The more they spend of any extra income received, i.e. the higher
their marginal propensity to consume the greater this multiplier effect will be.
If people in general spend 80% of any extra income they earn, their marginal propensity to
consume (MPC) is 0.8
M.P.C.can therefore be calculated as CHANGE IN CONSUMPTION
CHANGE IN INCOME
In the diagrams below, the initial equilibrium levels of national income are indicated by E.
In order to increase this level Government spending (G) is increased by the same amount in
each of two economies.
In the left-hand diagram, MPC is high.
You can see the effect on national income (Y) of this government spending as it works its way
round the economy in successive spending rounds
(look at the horizontal gap between E and E+)
In the right-hand diagram MPC is lower. The change in national income created by the same
change in Government spending is lower, because the multiplier effect is lower.

HIGH MPC AD line is steep as

LOW MPC AD line is less steep as

AD1

people spend a high proportion of

any extra income

people spend a lower proportion of any

extra income

AD1

AD

AD
G
G

NATIONAL INCOME (Y)

E+

NATIONAL INCOME (Y)

E+

Look at the gaps between E and E+ in both diagrams. What do

you notice?
1

The Multiplier effect or the National Income Multiplier can be described as:

The Change in National Income

The change in Injection or Withdrawal

eg: 100 billion

20 billion

MULTIPLIER = 5

It is calculated by this formula:

1
1 MPC
As you will see from worked examples, the higher the MPC the higher the value of the
multiplier

Example 1
If MPC = 0.75
Then the Multiplier =

1 =
1 0.75

1
0.25

So, for every injected or withdrawn from the economy there is a change of 4 in
national income

Example 2
If MPC = 0.4

Calculate the multiplier

What do you notice?

THE MULTIPLIER IN AN OPEN ECONOMY

This formula will always work:

1
1 MPC
In an open economy, that is one that engages in foreign trade (as all economies do) MPC,
that is the spending taking place in the domestic economy will be reduced by the level of
money spent on imports.
It will also be affected by the general level of taxation.
To give a true full picture of the value of the national income multiplier, we therefore need to
take spending on imports and the level of taxation into account.
The full multiplier can therefore be expressed as

1
s+t+m

What do you notice about these

three elements? Collectively
they are

where s = the proportion of national income saved

t = the proportion of national income taxed
m = the proportion of national income spent on imports