The Spending Multiplier (02/24/17)

The Spending Multiplier Effect 

·         An initial change in spending (C, I_G, G, X_N) causes a larger change in aggregate spending or Aggregate Demand (AD).

·         Multiplier = Change in AD / Change in Spending = ∆ AD / ∆ C, I_G, G or X_N

·         Why does this happen?

·         Expenditures and income flow continuously, which sets off a spending increase in the economy

Calculating the Spending Multiplier

·         The Spending Multiplier can be calculated from the MPS or the MPC.

·         Multiplier = 1 / 1 – MPC or 1 / MPS

Calculating the Tax Multiplier

·         When the government taxes, the multiplier works as 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 then the multiplier is +, because there is now more money in the circular flow.