Unit 3: Multipliers

March 27, 2018

Multipliers

The Spending Multiplier Effect

• An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending, or Aggregate Demand (AD)

Multiplier = (Change in AD)/(Change in Spending)

Multiplier = (Change in AD)/(Change in C, Ig, G, or Xn)

• Why does it happen?
• Expenditures and income flow continuously which sets off a spending increase in the economy.

Calculating the Spending Multiplier

• The Spending multiplier effect can be calculated from the MPC or the MPS

Multiplier = 1/(1-MPC) OR 1/MPS

• Multiplier are (+) when there is an increase in spending and (-) when there is a decrease.

Calculating the Tax Multiplier

• When the government taxes, the multiplier works in reverse.
• Why?
• Because now money is leaving the circular flow.
• Tax Multiplier (note: it's negative)

= - MPC / (1-MPC)  OR  - MPC / MPS

• If there is a tax - cut, then the multiplier is (+), because there is now more money in the circular flow.