Macroeconomics – Fiscal Policy -The Multiplier Effect

The multiplier effect

Factors affecting the value of the multiplier

The multiplier effects
The multiplier effects
  • The propensity to save.
  • The propensity to import.
  • The propensity to tax.
  • The amount of spare capacity.
  • Avoiding crowding out effects.

The Propensity to Consume

  • The higher is the propensity to consume domestically produced goods and services, the greater is the multiplier effect.
  • The multiplier effects will be higher when consumer  confidence is high and thus their willingness to spend any additional gains in income in the domestic  economy.
  • The government can influence the size of the multiplier through changes in direct taxes. For example, a cut in the rate of income tax will increase the amount of extra income that can be spent on further goods and services.

The Propensity to Purchase Imports

  • If consumers purchase imported goods/service, the demand is not passed onto further spending on goods produced in the domestic market. In other words, it leaks out of the circular flow of income and spending with the consequent decrease in the value of the multiplier.

Spare Capacity

  • In order for the multiplier to take effect, there needs to be sufficient spare capacity to produce the extra output. 

Crowding Out Effect

  • For example, the Government’s spending or the lowering of taxes can lead to a rise in government borrowing or an increase in inflation which will ultimately raise interest rates and has the effect of slowing down economic activity.

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