Chapter 6

Multiplier
 Multiplier
 The multiplier is the ratio of the change in income to the
change in AD.
 Multiplier shows how many times the effect of an initial
change in AD is multiplied by causing changes in
consumption and finally in the aggregate income.
 The formula for multiplier (K) is,

 The size of multiplier depends upon the size of the

marginal propensity to consume (MPC).
 Higher the MPC, higher is the size of the multiplier and
lower the MPC, lower shall be the size of multiplier.

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 Investment Multiplier
 Investment multiplier refers to the ratio of the change in the
equilibrium income to a change in investment.
Example

 Given, C = 200 + 0.75Y and I = 100. What is the equilibrium income level
when there is an increase in investment by 50 million?
  Solutions:
Y = Ki x AD New equilibrium income level = Y + Y
= x AD =1200 + 200
= x 50 =1400 m
Y = 200 million

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 Government Expenditure Multiplier
 The government expenditure multiplier refers to the ratio of the change
in the equilibrium income to a change in government expenditure
assuming there is no change in taxes.
Example

 Given, C = 200 + 0.75Y; I = 100 and G = 50. What is the equilibrium income
level when there is an increase in government spending by 50 million?
Solutions:
Y = K x AD New equilibrium income level = Y + Y
= x AD = 1400 + 200
= x 50 = 1600 m
Y = 200 million

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 Inflationary gap
• Inflationary gap occurs when national income exceeds the full employment level.
• Inflationary gap can be caused by the increase in aggregate expenditure.
• The inflationary gap is measured as the excess of the aggregate expenditure over
the full employment aggregate supply, Yfe.
Y=AD

Aggregate Demand
C+I+G +(X-M)

Yfe < Y
Inflationary Gap C+I+G +(X-M)fe
A
increase the general price level.
The inflationary gap of AB will
B

National Income
0 Yfe Y

practice contractionary fiscal policy through reducing government expenditure and raise taxes.
To reduce the inflationary gap of AB, contractionary policy can be implemented. Government can
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 Deflationary gap
• Deflationary gap occurs when national income below the full employment level.
• The deflationary gap is measured as the difference between the aggregate
expenditure over the full employment aggregate supply, Yfe.

Y=AD
Aggregate Demand
C+I+G+(X-M)fe

C C +I+G + (X-M)

D
Yfe > Y
Deflationary Gap

National Income
0 Y Yfe
practice expansionary fiscal policy through increase in government expenditure and tax cut.
To reduce the deflationary gap of CD, expansionary policy can be implemented. Government can
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