Multiplier Term

Multiplier Term

Multiplier, a term developed by Keynes, used to define the ultimate increase in national income which results from a given increase in expenditure. Thus, if an increase in investment expenditure of £100,000 causes an increase in national income of £500,000, the multiplier is five. Since the level of employment in an economy depends on the level of total expenditure, the multiplier has been used to measure the effect on employment of increases in components of the national income or expenditure. The multiplier is normally larger than one; its significance is that, in order to achieve a given increase in employment or income in a given period, the initial increase in expenditure (which may be by Government on goods and services; by persons on consumption; by foreigners on exports; or by business men on capital goods), can be smaller than the desired final increase.

Suppose national income is initially running at the rate of £100 million per period, generated by investment spending of £30 million and consumption of 470 million, the marginal propensity to consume (the proportion of the increase in income that is spent on consumption) is 10% and there is an increase in (say) investment of £1 million per period, commencing in period r. In consequence national income in period ' will rise by the same amount, and consumption remains constant. In period 2, So per cent (the marginal propensity to consume) of the initial increase in income is consumed, so that consumption increases by £800,000; national income therefore increases by a further £500,000. In period 3, 50 per cent of the increase in national income in period z is passed on as consumption, and national income increases by a further £640,000.

Time Period Investment Consumption National Income

0 30,000,000 70,000,000 100,000,000

I 31,000,000 70,000,000 101,000,000

2 31,000,000 70,800,000 102,500,000

3 31,000,000 711440,000 102,440,000

31,000,000 74,000,000 105,000,000

This process continues, and in each period 50 per cent of the increase in income of the previous period is passed on by individuals who, we have assumed, spend £0.80 of any additional £1 of income. Eventually, the increase in income will approximate to Es million as a result of the initial increase in investment of £1 million. Obviously the larger the fraction of each period's increase that is passed on in induced consumption expenditures, the larger the eventual rise in total expenditure. (For the mathematically minded, the relation between the community's marginal propensity to consume and the value of the multiplier is, formally: where c is the marginal propensity to consume. Thus at one limit where c = 0, i.e. all increases in income are saved, the multiplier will be one; at the other limit where c ', i.e. all increases in income are spent, the multiplier will be infinity up to the 'ceiling' of maximum employment.) While useful in explaining processes, the multiplier is of doubtful use as a forecasting device since its values in any one period may not necessarily throw much light on the relationship between investment and expenditure in following periods. Some economists also question the theoretical basis of the concept.

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