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= change in AD/ change in C, Ig, G, OR Xn

Why does it happen?

• Expenditures and income flow continuously which sets off on spending increases 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 positive when there is an increase in spending and negative where 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 its 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.