Unit 3 - 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 = (Δ AD) / (Δ C, Ig, G, or Xn)
• Why does this happen?
• expenditures and income flow continuously which sets off a spending increase in the economy

Calculating the Spending Multiplier

• the Spending Multiplier can be calculated from the MPC or the MPS
• Multiplier = 1 / (1 - MPC) or 1 / MPS
• Multipliers 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 multiplier is (+), because there is now more money in the circular flow