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Multiplier
 

 

A measure of the effect on total national income of a unit change in some component of aggregate demand. Suppose that an economy is initially at less than full employment, with given levels of aggregate investment, consumption and national income. Then suppose that, for some reason, firms increase the rate of invest­ment expenditure, i.e. they increase their expenditure on plant, machinery and buildings. We then expect national income to increase by the amount of this increase in expenditure. This investment expenditure is paid out as wages, salaries and profits to suppliers of factor services to the investment goods industries. The recipients of this income will save a portion of it and will spend the rest on buying goods and services, which creates income for the suppliers of those goods and services. At this stage the total increase in national income is equal to the initial increase in investment expenditure plus the portion of that increase-which is respent, since this respending has in turn generated new income and output. The income generated by the respending will again be partly saved and partly spent, in turn generating new income which is partly saved and partly spent, and so on, ad infinitum. The result of this is that the total increase in national income resulting from the initial increase in investment will, in the end, be several times !arger than the increase in investment, i.e. it will be some multiple of the increase in investment. The expression which gives the value of this multiple is called the multiplier, and the overall effect of the investment increase is called the multiplier effect.

To show how the multiplier is determined, suppose that throughout the economy a proportion (b) of any increase in income is respent, while the remainder (1 - b) is saved. If investment increased by, say, 10, then the amount which is respent at the first 'round' is given by b x 10, and so the total income generated by the increase in investment is 10+ 10b.

 

The multiplier has played an important role in macroeconomic analysis since its use by Keynes as a central element in his model of the economy. When the word 'multiplier' is qualified by the word 'investment', the concept is used to refer only to the multiplier effects of an increase in investment. However, the multiplier concept is of general application, and can be shown to apply just as well to changes in export demand, government expenditure and taxation. Note, however, that if there is full employment in the economy, the simple multiplier described here is unlikely to provide an adequate prediction of the consequences of an increase in investment. This is because the increase in demand for investment goods will cause rising prices and rates of interest rather than an increase in real income.

Reference: The Penguin Dictionary of Economics, 3rd edt.