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The Simple Multiplier

Expert reviewed • 14 August 2024 • 5 minute read

What is the Simple Multiplier?

Expert reviewed • 14 August 2024 • 5 minute read

In the study of economic growth, the simple multiplier measures the change in aggregate output (GDP) resulting from an initial change in spending (usually government spending or investment). The simple multiplier effect explains how initial spending can lead to a greater overall increase in economic activity.

What is the Simple Multiplier Formula?

The simple multiplier is represented by the formula:

k=11−MPCk=\frac{1}{1-MPC}

Where:

  • k=k= The Multiplier
  • MPC=MPC= The Marginal Propensity to Consume

Understanding the Components

  • Multiplier (K): This represents the factor by which changes in spending produce an effect on total national income.
  • Marginal Propensity to Consume (MPC): This is the proportion of additional income that a consumer spends on goods and services as opposed to saving it. For example, if a consumer receives an extra $100 and spends $80 of it, the MPC is 0.8.

What is the Multiplier Effect?

The simple multiplier demonstrates how an initial change in spending can lead to a larger change in national income. Here's a step-by-step explanation:

  • An initial injection of spending occurs (e.g., increased government expenditure).
  • This spending becomes income for others in the economy.
  • A portion of this new income is spent (determined by the MPC).
  • This new spending becomes income for yet others.
  • The process continues, with each round of spending being smaller than the last.
  • The total change in national income is larger than the initial change in spending.

These steps therefore validate the following formula:

National Income (Using Simple Multiplier)

ΔY=k×ΔAD\Delta Y=k\times\Delta AD

Where,

  • ΔY=\Delta Y= National income
  • k=k= Simple multiplier
  • ΔAD=\Delta AD= Change in aggregate demand

Practice Question 1

Suppose the Australian government decides to increase infrastructure spending by $10 billion. According to the Australian Bureau of Statistics, the average MPC in Australia is approximately 0.75 (meaning 75% of additional income is spent). Using this information, what could be the potential increase in national income?

Using the simple multiplier formula:

k=11−MPC=11−0.75=10.25=4k=\frac{1}{1-MPC}\\=\frac{1}{1-0.75}\\=\frac{1}{0.25}\\=4

This means that the $10 billion increase in government spending could potentially lead to a total increase in national income of:

ΔY=4×$10b=$40  billion\Delta Y= 4\times \$10 b\\=\$40\;billion

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