Multiplier effect
The multiplier effect describes how an initial change in spending can generate further rounds of income and expenditure. Its size depends on leakages such as saving, taxes and imports, as well as economic conditions and capacity. A simplified model is useful for explanation, but it does not establish a guaranteed real-world effect of a policy.
Worked example
In a simplified closed economy with no taxes and a marginal propensity to consume of 0.8, the spending multiplier is 1/(1−0.8) = 5. An initial $10 million increase could raise equilibrium income by $50 million under those assumptions.
Common mistake
Applying the simple formula unchanged to an economy with taxes and imports, or assuming extra spending always raises real output rather than prices.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | BT | Supporting | September 2026–June 2027 |
| FIA | FBT | Supporting | September 2026–June 2027 |