# Macroeconomics – Fiscal Policy -The Multiplier Effect Q3. An open economy has a marginal propensity to save of 0.3, a marginal propensity to tax of 0.25 and a marginal propensity to import of 0.25.

Using the concept of the multiplier, calculate the final value of GDP increase following an initial cash injection of 2.5 million euros?

## Workings

• The multiplier when there are three leakages (Savings, imports and taxation))
• = 1/ the sum of the marginal rate of withdrawal from the circular flow.
• =1/ (MPS + MRT + MPM)
• MPS = 0.3, MRT = 0.25 and MPM= 0.25
• Therefore the sum of the marginal rate of leakage = 0.8
• Therefore the coefficient of the multiplier = 1/0.8 = 1.25
• An injection of 2.5 million euros will lead to a final change in national income 1.25 x 2.5m = 3.1 million euros.

## Workings

• 1.MPS = (1 –MPC) = (1- 0.7) = 0.3.
• 2. The value of the multiplier: 1/1- (0.7 -0.3) = 1/1-0.4 = 1.67 OR 1/(0.3 +0.3) = 1.67
• 3. The shortfall in national income = (520m – 400m)
• =120m/1.67. =71.86 million euros.
• The Government must increase spending by this amount.