Page 132 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 7: Concept of Multiplier

Notes

Task See the national income accounts of India for last five years and calculate the value
of investment multiplier.

7.2.2 Government Spending Multiplier

Suppose government increases G by the amount of G. The multiple impact of G on equilibrium
income is identical with the impact of change in investment. Just like the investment multiplier
is 1/MPS, similarly
1
Government spending multiplier =
MPS
1
and change in total national income ( Y)is: Y G
MPS

7.2.3 Tax Multiplier

Suppose government reduces T. This raises disposable income (Yd) of the households by an
equal amount. Rise in Yd raises consumption spending (C) but not by the amount of Yd but by
the amount of Yd MPC or T MPC. Since MPC is less than one the rise in C is less than
the fall in T.

Example: Let government reduce T by 1. This raises Yd by 1. Suppose MPC is 0.8.
Therefore, C rises by 0.80. (and not by 1). It means that the impact is not the same as that of
1 of government spending. The impact is smaller.
T leads to change in Yd. The change in Yd ( Yd) leads to change in C by ( Yd.MPC). Change
in Y on account of multiplier effects of C is :
1
Y = C =
MPS
1
= ( Yd.MPC) ( C Yd.MPC )
MPS

1
= (–Δ T.MPC) ( Yd – ) T
MPS
MPC
= – T
MPS

MPC
= T (– )
MPS
MPC
We find that T leads to (– ) times change in income. Therefore,
MPS
MPC
Tax multiplier = –
MPS

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