Multiplier Effect Assignment Help

Multiplier Effect

The term multiplier effect refers to the proportional increase in the final income arising from the introduction of new demand in the income flow.

Multiplier Effect Definition

Due to an initial change in the aggregate demand, there can be a more significant impact on the final income. This is called the multiplier effect.

Whenever there is the opportunity to inject new spending, it can lead to a much larger increase in the final national income. In most cases, you can use this term to refer to the relationship between government spending or investments and the total national income.

This situation arises because the firms will spend a portion of the new injected spending, creating new income opportunities for individuals and firms. Similarly, these firms and individuals spend a part of their income, creating opportunities for others to generate revenue. This cyclical process continues until there remains no extra income that you can spend.

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What Is Spending Multiplier?

In any income-expenditure model, the spending multiplier, also known as the fiscal multiplier, is the economic measure of the effect that the change in government spending has on the overall GDP.

You can also define it as the ratio of the GDP to the aggregate expenditure change that caused the change in GDP.

Economists use this multiplier to determine what amount of stimulus would be appropriate for the economy. For example, if consumers spend more money instead of saving, it will increase the multiplier and give rise to a more significant stimulus.

What Do You Understand By Tax Multiplier?

Tax multiplier (TM) refers to the change in a country's GDP due to the government's decision to change the tax structure. Usually, the GDP increases due to a decrease in taxes and vice versa.

There are two kinds of tax multipliers, depending on whether the tax changes impact only the consumption or all GDP components. These are:

Simple tax multiplier- In this kind, you have to assume that any increase or decrease in taxes affects only consumption and has no effect on government investments and expenditures.

Complex tax multiplier – In this case, any change in tax affects the aggregate production and expenditure along with the consumption.

Economists analyze this value to understand better how taxation policy changes affect a country's aggregate income level.

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Expenditure Multiplier

The expenditure multiplier is used to measure the change in aggregate production due to a change in autonomous expenditures. These can include investment and consumption expenditures, government purchases and net exports.

Just like tax multipliers, expenditure multipliers are also of two types- simple and complex.

Simple expenditure multiplier – This multiplier is a simple variation of the expenditure multiplier family and consists of only the induced consumption. It is the ratio of the change in aggregate production to an autonomous change in aggregate expenditure.
Complex expenditure multiplier – These include various combinations of induced combinations such as investments, taxes, government purchases, etc.

The value of the expenditure multiplier increases due to induced consumption, investment and government purchases. Meanwhile, it decreases due to induced taxes and imports.

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Multiplier Formulas

Economic analyzers use many formulas to calculate multipliers accurately. Let's look at some of these:

Multiplier effect formula

You can find the multiplier effect by the ratio of the change in income to the ratio of change in expenditure. Therefore, the formula is,

Multiplier = change in income/Change in expenses

Another way to express it is,

Multiplier (k) = Change in real GDP (Y)/change in injections

Spending or expenditure multiplier formula

The concept of spending multiple deals with understanding how an increase in spending results in a proportional increase in the overall aggregate GDP.

However, to understand this formula, you need to have some knowledge about MPC and MPS.

MPC stands for marginal propensity to consume, which represents the proportion of pay raise you spend on consumption rather than saving

MPS stands for Marginal propensity to save, representing the proportion of pay raise that you save instead of spending.

Since you can either spend or save your money, MPC + MPS = 1.

Now, the spending multiplier formula is,

1/(1-MPC), as a higher MPC means that you spend a more significant proportion of the income on consumption, which results in a higher spending multiplier.

Now, since you have already established MPC = MPS = 1, you can write the formula as,

Spending multiplier = 1/MPS.

Tax multiplier formula

A tax multiplier is multiple by which the GDP of a country increases due to a decrease in taxes and vice versa.

The formula in the case of simple tax multiplier is,

TMs = MPC/MPS,

Or, TM = MPC/(1-MPC)

In case of complex tax multiplier, the formula becomes,

TMc = MPC/1-{MPC x (1-MPT) + MPI + MPG + MPM}

Where, TMs = Simple tax multiplier

TMc = Complex tax multiplier

MPS = Marginal propensity to save

MPC = Marginal propensity to consume

MPT = Marginal propensity to tax

MPI = Marginal propensity to invest

MPG = Marginal propensity of government expenditures

MPM = Marginal propensity to import

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Money Multiplier Calculator

Legally, banks are required to hold a certain amount of money in their reserves to meet any potential withdrawal demands. The phenomenon of generating credit due to this fractional reserve is called the money multiplier.

The formula for it is,

Money multiplier = 1/Required reserve ratio

The required reserve ratio is the fractional amount that the banks keep as reserve divided by the total amount of deposits.

Using a money multiplier calculator can-

Help you understand how a change in the money supply directly related to a change in the monetary base of the bank
Assist you in getting familiar with the formula

You can find such calculators on omnicalculator.com, mathcelebroty.com and icalc.co.il.

Keynesian Multiplier

Richard Kahn introduced the principle of the Keynesian multiplier in 1931. It stated that economic flourish is mainly dependent on how much the government spends or invests in the economy. Such an investment will lead to a massive increase in employment opportunities and economic prosperity.

This theory states that any increase in production leads to a rise in income. This will ultimately lead to a rise in spending.

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Multiplier Effect in Economics

To sum it up, the multiplier effect in economics refers to the overall increase in national income due to an initial injection in the economy, most commonly by the government.

It is possible to use the multiplier effect assignment help concept in every situation whenever there is an investment in the economy. For example,

When the government proposes to build new roads and railway systems
When there is a decrease in taxes
When there is an increase in exports

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