What is the multiplier effect? how can spending reverberate both positively and negatively for the economy? Discuss this, making sure to mention the multiplier and out propensities to save and to spend
Multiplier = 1/MPS = 1/(1-MPC)
MPS: Marginal propensity to save
MPC: Marginal propensity to consume
According to the multiplier effect, a change in disposable income, investment, government spending, net exports etc, causes a change in output by a multiple of the initial change.
Positive for economy
When economy is in recession, and governmetn reduces taxes, the disposable income rises and consumers spend more. Which leads to greater rise in income than the initial reduction in taxes.
Negative for Economy
Suppose investment rises which leads to lower aggregate demand. As a result, total output falls more than the initial reduction in investment.
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