Question

How is the multiplier related to MPC?

Answer 1

The multiplier is directly related to the marginal propensity to consume (MPC), which refers to the portion of additional income that people spend on consumption.

Multiplier (K) = `1/(1-"MPC")`

Higher MPC means people spend more of their extra income. This increases consumption, which then becomes income for others, leading to a larger multiplier.

Lower MPC means people spend less and save more, reducing the chain effect of spending, so the multiplier is smaller.

Example:

If MPC = 0.5,

K = `1/(1-0.5)`

K = 2

If MPC = 0.8

K = `1/(1-0.8)`

K = 5

So, the greater the MPC, the larger the multiplier.