Macroeconomics Multiplier Effect

Multiplier Effect
The multiplier effect refers to the effect on national income and
product of an exogenous increase in demand.
For example, suppose that investment demand increases by
one. Firms then produce to meet this demand. That the national
product has increased means that the national income has
increased. Consequently consumption demand increases, and
firms then produce to meet this demand.
Thus the national income and product rises by more than the
increase in investment. The multiplier effect is greater than
one.
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Macroeconomics Multiplier Effect

The Multiplier Process

The multiplier process is a continuing chain:

demand up ⇒ product up ⇒ income up

⇒ demand up ⇒ product up ⇒ income up
⇒ demand up ⇒ product up ⇒ income up
⇒ demand up ⇒ etc.

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Macroeconomics Multiplier Effect

Autonomous Versus Induced Demand

The initial exogenous increase in demand is an autonomous
increase.
The subsequent increase in consumption demand is an induced
increase.

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Macroeconomics Multiplier Effect

Multiplier Formula
We calculate the total increase in national income and product.
In the multiplier process,

demand up 1 ⇒ product up 1 ⇒ income up 1

⇒ demand up mpc ⇒ product up mpc ⇒ income up mpc
⇒ demand up mpc2 ⇒ product up mpc2 ⇒ income up mpc2
⇒ demand up mpc3 ⇒ etc.

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Macroeconomics Multiplier Effect

Figure 1 shows the multiplier process.

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Macroeconomics Multiplier Effect

Figure 1: Multiplier

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Macroeconomics Multiplier Effect

Evaluation
The total increase in the national income and product is

∆y = 1 + mpc + mpc2 + mpc3 + · · ·

1
= .
1 − mpc
Since 0 < mpc < 1, therefore ∆y > 1; the multiplier effect is
greater than one.

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Macroeconomics Multiplier Effect

Calculus Derivation
In the model
c [y (i)] + i + g = y (i) ,
the expression y (i) emphasizes that the solution y depends on i.

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Macroeconomics Multiplier Effect

Differentiation
Differentiating with respect to i gives
dc dy dy
+1+0 = .
dy di di
The first expression invokes the chain rule.
Rearranging gives


dc dy
1− = 1,
dy di
so the multiplier
dy 1
= .
di 1 − dy
dc