Eco help (1 Viewer)

[rebeka94]

Can anyone please explain the multiplier effect to me, preferably using an example?

 

[twistedrebel]

The multiplier effect is say a goverment spends 100$ in the economy. The government say spends the 100 to build a new building. The Contractor gets the money, who in turn buys materials/labour to build it. Those labours get wage and spend that wage at the shops. Then the shop keeper gets that money and spends it to meet his need, e.g. new TV. Then the TV guy gets the money and spends to buy buy new car. then the car guy gets the money and so on.

The multiplier is just if the $X is injected, how many times will it multiple throughout the economy.

 

[slyhunter]

 

[twistedrebel]

thanks for the formula sly

 

[Bobbo1]

Another way of thinking of the formula is taking it as a geometric progression as in maths: remember Multiplier (k) = 1/MPS = 1/1-MPC = 1/1-r
Where a = amount of government spending and r = MPC

So assume MPC, the marginal propensity to consume is 0.8, i.e, 80% of extra/additional income earnt will be consumed by the consumers.
So if the government spends $10,000 and MPC in a city is 0.8.
Then the first round of spending will be $10,000 on familes (e.g.)
The families will go and spend (0.8 x 10,000) $8000 out of their $10,000 on clothes
Clothes shop owners who receive the $8000 will spend (0.8 x 8000) $6400 on cotton to make their clothes
etc. etc.

So the effective total amount will be: $10000 + $8000 + $6400 + .... = k (multiplier) x $10000

But the multiplier k = 1/1-MPC = 1/1-0.8 = 5
So the total amount = 5 x $10,000 = $50,000


Ok, hope you get all of that - this is one of the most interesting parts in the eco syllabus so have fun with it