Concept of Multiplier (K)

The multiplier measures the effect of a change in any of the components of aggregate demand such as private consumption, private investment, government expenditure, export and import on national income.

The multiplier is the ratio of change in income to a change in any of the components of total spending. For example, if total investment changes by a stated amount, the extent to which income will change can be determined by using the multiplier. If aggregate demand is lower than total output there will be a fall in national income. To increase national income, therefore, aggregate expenditure has to be increased. The multiplier works in two directions, increasing or decreasing income at a faster rate than the change in expenditure.

CONSUMPTION EXPENDITURE AND THE MULTIPLIER

An increase in consumption expenditure leads, to higher increase in national income.

On the other hand, if consumption expenditure is reduced the fall in income will be greater than the rate at which consumption expenditure has been reduced. In this connection the multiplier can be defined as the ratio of increase or decrease in income to increase or decrease in consumer spending.

The multiplier (k) = 1/1 – MPC = 1/MPC     Δ Y / ΔC

Where k = Multiplier

MPC = Marginal Propensities to Consume

MPS = Marginal Propensities to Save.

ΔY = Change in National income

ΔC = Change in Consumption Expenditure.

A  Knowledge of the marginal propensity to consume or marginal propensity to save helps us to know the multiplier.

The knowledge of multiplier helps us to know the extent to which consumption expenditure should be increased or decreased to achieve a desired level of income or output.

The higher the MPC, the higher the multiplier effects and the higher the MPS, the lower the multiplier. Therefore, a higher MPC increases national income while a higher MPS will reduce it.

Example

1. If the marginal propensity to consume is 0.75, calculate the multiplier.
2. By how much must consumption expenditure be increased to increase income by N2000.00?

Solution

K = 1                  = 1                 = 1

1 – MPC      1 – 0.75           0.25   = 4

K =     ΔY

ΔC

4/1 = 2000/ C

C = N2000 / 4 = 500.00