Multiplier

A multiplier can be thought of as a tool for governments, or a measure of how an investment by a firm affects the economy. Before discussing any further lets have a look at the definition by Parkin and Powell “The multiplier is the amount by which a change in autonomous expenditure is magnified or multiplied to determine the change in equilibrium expenditure and real G.D.P” By autonomous expenditure what we mean is ‘self directing’ expenditure. The multiplier informs users of the effect of such an expenditure, in terms of overall expenditure in the economy. For e.g if Government spends £100 million the multiplier tells them by how much this £100 million is multiplied to give the final amount of expenditure in the economy as a result of this. We will discuss exactly how the multiplier works further on.

The multiplier is useful because, sticking with our example of government spending, if the government which to increase aggregate income by a certain amount the multiplier can aid them in finding out how much to inject into the economy.

It is also important to note that the actual size of the multiplier depends on many factors such as the marginal propensity to consume. This is the proportion of the ‘extra’ income that is consumed rather than saved. The multiplier also depends on imports and taxes.

We will look at this last factor in more detail.

Show what the multiplier will be for government spending in a keynesian cross model with a closed economy (a) assuming lump sum taxes (b) assuming a fixed proportional tax rate First lets explain the keynesian cross model. This shows the relationship between aggregate demand (AD) and income (Y). An important assumption of this model Is best described by Andy Denis : “The economy is demand-determined at all levels of...