A small multiplier may not be undesirable for the economy.

Introduction

The multiplier effect is the effect of an increase in autonomous expenditure resulting in a larger increase in national output and hence national income. The multiplier is the number of times by which national output and hence national income rises due to an increase in autonomous expenditure.

Many students think that a small multiplier is undesirable for the economy.ย This economic misconception will be discussed in greater detail in economics tuition.

Exposition

An increase in autonomous expenditure will lead to an increase in aggregate demand. When aggregate demand rises, firms will employ more factor inputs from households to increase production and hence will pay households more factor income. When householdsโ€™ income rises, they will increase consumption expenditure. Due to the increase in consumption expenditure and hence aggregate demand, firms will employ even more factor inputs from households to further increase production and hence will pay households even more factor income. When this happens, householdsโ€™ income will rise further which will induce them to further increase consumption expenditure. Therefore, the initial increase in aggregate demand due to the increase in autonomous expenditure will lead to increases in consumption expenditure and hence further increases in aggregate demand resulting in a larger increase in national output and hence national income and this is commonly known as the multiplier effect. The multiplier is the inverse of the marginal propensity to withdraw which is the sum of the marginal propensity to save, the marginal propensity to tax and the marginal propensity to import. The marginal propensities to save, tax and import are the proportions of an increase in national income that are saved, taxed and spent on imports. Therefore, the multiplier will be smaller the higher the savings, the higher the income taxes and the higher the imports. Many students think that a small multiplier is undesirable for the economy as it limits the effectiveness of demand-side policies which will make it difficult for the government to achieve the four macroeconomic goals of high economic growth, low unemployment, low inflation and a balance of payments equilibrium. However, although this aspect of a small multiplier is correct, many students have not fully understood the concept as they have failed to recognise the benefits. A small multiplier may be desirable for the economy. The economy may be at or near the full-employment equilibrium. If this happens, a small multiplier may prevent a decrease in autonomous expenditure from causing a substantial decrease in aggregate demand and hence national output and therefore national income to fall substantially from the full-employment level. Similarly, it may prevent an increase in autonomous expenditure from causing a substantial increase in aggregate demand and hence the general price level to rise substantially. Therefore, one should not think that a small multiplier is undesirable for the economy.

 

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