a.

Explain the concept of the multiplier, and explain the role of the marginal propensity to consume

in determining the size of the multiplier.

The multiplier is related to the circular flow of income. It is mostly used in relation to national

income .thus the national income multiplier predicts that how a rise in injections into a circular

flow will affect the levels of national income in the economy.

 Injections: Government Spending (G) , Exports (X) and Investment (I)

 Withdrawals: Imports (M) Saving (S), and Taxation (T)

Marginal Propensity (mpc) - The marginal propensity explains the proportion that the consumer

is ready to spend from his increased income. This proportion will be spent on the variable under

consideration

The multiplier can be calculate as 1/1-mpc, so an increase in mpc will lead to increase in multiplier

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b. Explain how the size of the multiplier will change when one brings in the role of the marginal tax

rate.

When the marginal tax rate is reduced the multiplier will increase , since less money spent on tax

more will be spent on buying goods and hence increasing the multiplier and vice versa

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c. Using the concepts in parts a and b above, calculate the slope of the AE curve and the size of the

multiplier if MPC = 0.75. Then, calculate the revised slope of the AE curve and the multiplier when

you know that the imports and the marginal tax rate will reduce the slope of the AE curve by

another 0.30.
Slope of the AE curve = Marginal propensity to income MPC=0.75

Multiplier = 1/1-mpc=1/1-0.75=4

Part 2

New slope of the AE curve=0.75-0.3=.45

Multiplier=1/1-0.45=1/.55=1.818

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