What is the multiplier effect? What relationship does the MPC bear to the size of the multiplier?

Question

What is the multiplier effect? What relationship does the MPC bear to the size of the multiplier?

Answer 1

In economics, the multiplier effect refers to the idea that an initial spending rise can lead to an even greater increase in national income. In other words, an initial change in aggregate demand can cause a further change in aggregate output for the economy.

The multiplier effect is a tool used by governments to restimulate aggregate demand.  Marginal propensity of consumption

The size of the multiplier depends on the

marginal propensity to consume: The higher the marginal propensity

to consume, the higher the multiplier.

If the marginal propensity to consume is equal to 0.8 (4 / 5), then the multiplier can be calculated as:

Multiplier = 1 / (1 – MPC) = 1 / (1 – 0.8) = 1 / 0.2 = 5