Explain the multiplier process, calculate the multiplier from the marginal propensities, and use it to analyse the effect of a change in injections on the level of economic activity

What this dot point is asking

SCSA wants you to explain the mechanism, calculate the multiplier from the marginal propensities, and apply it to a change in spending. Expect a calculation task and a short response linking the multiplier to the business cycle and to fiscal policy.

The multiplier process

When spending is injected into the economy, it does not stop with the first recipient.

The size of each round depends on how much income is passed on as spending and how much leaks out as saving, taxation and imports.

Calculating the multiplier

The multiplier depends on the marginal propensity to leak, the combined fraction of extra income withdrawn from the flow at each round.

Why leakages shrink the multiplier

At each round of spending, the leakages (saving, tax, imports) remove money from the circular flow, so each successive round is smaller than the last. The larger the marginal propensity to leak, the faster the rounds shrink and the smaller the total effect.

Applying the multiplier

The multiplier works in both directions. A rise in any injection (I, G or X) raises income by the injection times the multiplier; a fall in any injection, or a rise in a leakage, reduces income by the same logic. This is central to:

• Fiscal policy: the impact of government spending depends on the multiplier; a higher multiplier means stronger stimulus per dollar.
• The business cycle: the multiplier amplifies shocks, giving the cycle momentum.
• Confidence shocks: a fall in investment is magnified into a larger fall in income.