Expenditure Multipliers

introduction

The concept of the "multiplier" is at the very heart of Keynesian (and therefore macro in general) macroeconomics.  The central notion is that when there is an expenditure the money travels from one party to a second party to a third party to a fourth party and on and on and on.

In short, the money is respent and hence multiplied.

The bridge constructed in Cedarville during the summer of 2000 added to the local economy.  The initial expenditure by the state added "X" dollars to the economy as the materials, labor, etc. were paid for.  In addition the workers ate meals in the area, purchased gas, some may have traveled from outside the region to come to the area to work and stayed in local motels.  The initial expenditure by the state added more money to the economy than the simple cost of the bridge.  The initial expenditure was multiplied.

multiplier effect -- national income increases by more that the increase in autonomous expenditure

induced and autonomous expenditure

Expenditure may categorized into two categories:

  1. induced  expenditure
  2. autonomous expenditure.
The distinction is very important for understanding the multiplier because the "induced" expenditure is what causes the total amount spent to be greater than the initial expenditure.
autonomous expenditure -- sum of the components of AE that are not influenced by national income

induced expenditure -- sum of the components of AE that do vary as national income income varies


an increase in autonomous expenditure

The basic aggregate expenditure equation:

        AE = C + I + G + (X - M)

illustrates the categories of expenditure.  If one of these types of expenditure changes for any non income related reason, the AE curve will shift.  If expenditure increase the curve will shift up, if expenditure declines the curve will shift down.

Further, the initial change will be multiplied.  The final change in national income will be larger than the initial change in expenditure.

The following graph illustrates an increase in investment spending as the result of a presidential election.  Business people believe the new administration will view business endeavors more favorably than the previous administration.


 
 
Study Question:
Explain the income multiplier utilizing the roles of both autonomous and induced expenditure.

multiplier formula

A mathematical representation of the multiplier process is fairly easy to derive.  The derivation is not particularly important, but the formula and a basic understanding of the elements of the formula is important.

The formula for the simple income expenditure multiplier is:

If the MPC = .75, the simple multiplier = 4.

The higher the MPC, the larger the value of the multiplier because more money is respent by each person in the spending chain.

If the MPC = .9, the simple multiplier = 10.
 
 
Study Question:
Using a graph show how the Keynesian cross may be used to explain the concept of the multiplier.  Relate the graphical analysis to the basic mathematical formula for the multiplier.