The Multiplier

The multiplier effect is the process by which any change in a component of AD results in a greater final change in real GDP. When injections exceed leakages, aggregate demand will increase. This increase in AD will have a larger effect on the economy. This is because when people spend money, that expenditure then becomes the income of those who sell them the product, who in turn go out and spend some of the money. Therefore there is a knock on effect which is known as the multiplier. For example £100 of investment will increase AD in the economy by more than £100 (provided MPC isn’t £0).

The less leakages; the higher the MPC (the lower the MPS) and the less imports into a country, the more the effect of the multiplier. This means that any change in government spending will have a knock-on effect in the economy. If it reduces spending by £100 it is likely to cause a fall in GDP of more than £100.

The formula for the Multiplier is