Question

What is the multiplier is and how does it work?

Answer 1

In economics, the multiplier effect refers to an increase in final income that occurs due to a new injection of spending. Thus the size of the multiplier will depend upon household's marginal decisions to save called the marginal propensity to save (mps), or to consume, called the marginal propensity to consume (mpc). Because of the multiplier effect, small changes in government spending or investment can create huge changes in total output. Multiplier is computed as:

= 1 / (1 - MPC) = 1/MPS

A positive aspect of the multiplier effect indicates that macroeconomic policy can effect substantial enhancements with relatively small amounts of autonomous expenditures. On contrasr, negative aspect indicates little decline in business investment can lead to huge decline in business activity and, hence, create instability in the economy