Keynesian Multiplier

Unit 9 - Lesson 9.6

Learning outcomes:
Explain with reference to leakages & injections the nature and
importance of the Keynesian multiplier.
Calculate the Multiplier using the formula
Use the Multiplier to calculate the effect on GDP of a change in
an injection of investment, government spending or exports.
Draw a Keynesian AD-AS graph to show the effects of the
multiplier.
The Multiplier
If there is a change in one of the component of AD (C, I, G, X-M) the result will be
a change in Real GDP.

But by how much?

An increase in an AD component will increase more than the initial expenditure

that shifted AD.

If the Government spends $4 million on infrastructure improvements the AD

will shift and the effect on Real GDP will be greater than $4 million.
Why?
The simple answer - induced spending.

If a Government spends $4 million on an infrastructure project Real

GDP will increase by $4 million and will continue to be influenced by
induced spending.
The $4 million is used by the government to pay for materials, capital,
labor etc. The payment of money by the Government for the factors
of production becomes income for the owners of those factors.
They in turn start spending (consuming) and thus further influence
AD.
The cycle continues until there is no more money.
 Calculating the Multiplier
To calculate the Multiplier you need to think back to the Circular Flow with its leakages
and injections.

Marginal Propensity to Consume (MPC): the additional money or income

consumers/households spend on consumption of domestically produced goods.

Marginal Propensity to Save (MPS): the additional amount of money

consumers/households save. It is a leakage out of the Circular Flow Model.

Marginal Propensity to Tax (MPT): the additional income that is taxed. Also
represents a leakage out of the Circular Flow.

Marginal Propensity to Import (MPM): the additional income that is spent on

imported goods. Represents a leakage out of the economy.
Value of the Multiplier
The value of the Multiplier can be found using the following formula:

Multiplier = 1 divided by MPC = 1 divided by MPS + MPT + MPM

Therefore if we know the MPC we can calculate the Multiplier.

OR

If we know MPS, MPT & MPM

We can infer that the smaller the value of the denominator, the larger the
multiplier. This means the amount of leakages out of the Economy are
small.
Try it out.
In a country with a Real GDP of $50 billion and a MPC = , find the
change in Real GDP and the final value of GDP for each of the following:

1. An increase in net exports of $2 billion

2. A fall in Investment Spending of $3 billion
3. Increase in Government Spending of $7 billion
4. A decrease in Consumption Spending of $1.5 billion
Solutions
Calculate the Multiplier: 1 divided by 1 -

Multiplier = 3

1. Increase in net exports by $2 billion will increase Real GDP by $6

billion.
2. Decrease in Investment Spending by $3 billion will decrease Real
GDP by $9 billion.
3. Increase in Government Spending by $7 billion will increase Real
GDP by $21 billion.
4. Decrease in Consumption Spending by $1.5 billion will decrease Real
GDP by $4.5 billion.
The Multiplier and Price Levels

For the Multiplier to have the greatest possible effect on Real GDP, Price
Levels are constant.

If the Price Level is increasing, the smaller the size of the Multiplier effect.

If Price Levels continue to increase the size of the Multiplier becomes

smaller.

It is important to take this into consideration when illustrating the

effect of the Multiplier using the Keynesian AD-AS graph.