2.2 The Keynesian multiplier (HL)

Definition:

  • The multiplier is a factor by which GDP changes following a change in an injection or leakage.

The formula for the multiplier:

  1. Multiplier = 1 / (1 – MPC)
  2. Multiplier = 1 / (MPS + MPT + MPM), where:
  • MPC – Marginal Propensity to Consume
  • MPS – Marginal Propensity to Save
  • MPT – Marginal Propensity to Tax
  • MPM – Marginal Propensity to Import

Essentially, both formulas are the same. Which one you will have to use depends on the information you have.

You have to know:

  • how to calculate the effect on GDP resulting from a change in any of the Injections (Investment, Government spending, Exports)
  • what kind of a change is required in a given injection to reach a certain level of GDP

Example:

Question: Current GDP is $100 bn, MPS = 0.1, MPT = 0.2, MPM = 0.2. Government’s GDP target is $150 bn. How much does government need to increase their spending by to reach the target? How will the budget be affected?

Solution:

  1. What change of GDP we need to achieve: 150 – 100 = $50 bn
  2. Finding the multiplier: 1 / (0.1 + 0.2 + 0.2) = 2
  3. 50 / 2 = $25 bn is the value by which the government needs to increase their spending to reach the GDP target
  4. Find how much more will the governments earn in tax as a result of $50 bn increase in GDP: 50 * 0.2 = $10 bn (general formula: total change in GDP multiplied by the MPT)
  5. The government will spend $25 bn and there will be $10 bn increase in taxes collected. So effect on the budget: $10 – $25 = $-15 bn

Also, I remember while preparing for the IB Economics exam there was one question in one of the maths papers. It asked to show the multiplier effect on a diagram (2 marks).

multiplier effect

This is how the diagram for 2 marks had to look like. Exactly like that. The second shift in the AD (AD2 -> AD3) had to be bigger than the first one (AD1 -> AD2). Anything different to this (more AD curves, the two shifts being the same size, etc.) would score you 1 mark. However, always consult your teacher on matters like this as it is possible that the question is worded differently. That might change what is given in the markscheme/what the examiner is expecting.