Multiplier Effect

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

Calculating the Spending Mulitplier 

•  The spending multiplier can be calculated from the MPC or the MPS. 
• Mulitplier = 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 the multiplier is +, because there is now more money in the circular flow