Spending Multiplier

Spending Multiplier

It all depends on...

How much people save, and how much people consume

• MPC (marginal propensity to consume): how much you consume out of total earnings

MPS (marginal propensity to save): how much you save out of total earnings

The Basics

Things to Remember

• The higher the savings (MPS), the lower the multiplier

• Multiplier effect: the additional shifts in aggregate demand (change in total spending) that result when expansionary fiscal policy increases income (therefore increases consumer spending).
• AKA:

If you save 20% of your money, the formula becomes 1/MPS = 1/.2 = 5

If you save 50% of your money, the formula becomes 1/MPS = 1/.5 = 2

assuming no taxes or other expenditures - this money is direct and there is no other outlet for your money!

MPS + MPC = 1

THE FORMULAS

• When the MPC gets smaller, the multiplier gets smaller

spending multiplier =

If you consume 60% of your money, the formula becomes..

When the government invests money into the economy, how much more money are people spending/how much more product are people demanding...

The MPS is going to be a number between 0 and 1...

If you consume 20% of your money, the formula becomes ...

What is the effect?

The Idea

Example 1

• The spending multiplier showed that government spending brought about cycles of spending among consumers, and especially if used during a recession, would increase the employment rate and increase prosperity regardless of the form of the spending

Tax Multiplier

If the government increases military spending by $10 billion for a Syrian intervention, what effect does this have on the US's aggregate demand when the MPS is .2?

Tax multiplier represents the multiple by which GDP increases (decreases) in response to a decrease (increase) in taxes charged by governments

Total spending = Multiplier X Initial Spending

Aha... this explains why governments' economies thrive during wars, even if the economy was in a recession prior...because money put into the economy is ampified by consumer spending

- has a inverse relationship

Total spending = ?

Initial spending = 10 billion

Multiplier: 1/.2 = 5

? = 5 X 10 billion

It can move the aggregate demand curve outward, such as if government purchases of $30 billion causes the aggregate demand curve to shift more than $30 billion dollars.

Total spending = 50 billion

Example 3

Example 2

If initial government spending is $600 and the MPS is .2, how much will the GDP change?

If the marginal propensity to consume (MPC) is .6, the spending multiplier is?

Answer to example 3

Answer to Example 2

remember....

Quick Review

If the MPC increases, the spending multiplier increases

If the MPC decreases, the spending multiplier decreases

If the MPS increases, the spending multiplier decreases

If the MPS decreases, the spending multiplier increases

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