The multiplier, Managerial Economics

The Multiplier

In his theory Keynes asserted that consumption is a function of income, and so it follows that a change in investment, which we may call ΔI, meaning an increment in I will change Y by more than ΔI.  For while the initial increase in Y, ΔY, will equal ΔI, this change in Y itself produce a change in C, which will increase Y still further.  The final increase in income thus exceeds the initial increase in investment expenditure which is therefore magnified or "multiplied".  This process is called the multiplier process.

The Operation of the "Multiplier" 

The multiplier can be defined as the coefficient (or ratio) relating a change in GDP to the change in autonomous expenditure that brought it about.  This is because the Multiplier can be defined as the coefficient  (or ratio) relating a change in GDP to the change in autonomous expenditure that brought it about.  This is because a change in expenditure, whatever its source, will cause a change in national income that is greater than the initial change in expenditure.

For example, suppose there is an autonomous increase in investment which comes about as a result of decisions by businessmen in the construction industry to increase the rate of house building by, say, 100 houses, each costing £1,000 to build, investment will increase by £100,000.  Now this will be paid out as income to workers of all kinds in the building industry, to workers in industries which supply materials to the building industry, and others who contribute labour or capital or enterprises to the building of the houses; these people will in turn wish to spend these incomes on a wide range of consumer goods, and so on.  There will thus be a series of further rounds of expenditure, or Secondary Spending, in addition to the initial primary spending, which constitutes further increases in GDP.

This is because those people whose incomes are increased by the primary increase in autonomous expenditure will, through their propensity to consume, spend part of their increase in their incomes.  GDP increases through the Expenditure - Income - Expenditure cycle.

Posted Date: 11/28/2012 6:31:15 AM | Location : United States

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