Question

Value of MPS (Marginal Propensity to Save) is increased from 0.4 to 0.5. What would be the impact on Multiplier ?

• A. The size of the multiplier would be increased
• B. The size of the multiplier would remain the same
• C. Value of multiplier is undetermined
• D. The size of the multiplier would be decreased

Answer 1

The Correct Option is D

In economics, the multiplier effect refers to the proportional amount of increase in final income that results from an injection of spending. The formula for the multiplier (K) is given by:

\(K = \frac {1}{(1 - MPC)}\)

where MPC is the Marginal Propensity to Consume. Alternatively, since

\(MPC + MPS = 1\)

we can rewrite the multiplier in terms of MPS (Marginal Propensity to Save) as:

\(K = \frac {1}{MPS}\)

Initially, the MPS is 0.4, so the initial multiplier is calculated as:

\(K_{initial} = \frac {1}{0.4} = 2.5\)

When the MPS increases to 0.5, the new multiplier becomes:

\(Knew = \frac {1}{0.5}= 2\)

Since the new multiplier (2) is less than the initial multiplier (2.5), the size of the multiplier decreases. Therefore, when MPS increases, the multiplier decreases.

Hence, the correct answer is: The size of the multiplier would be decreased

Answer 2

The multiplier effect in economics refers to the concept that an initial change in spending (such as investment or government spending) leads to a larger overall change in national income. The magnitude of this effect is inversely related to the Marginal Propensity to Save (MPS), which represents the fraction of additional income that is saved rather than spent.

The multiplier is calculated as:

\( \text{Multiplier} = \frac{1}{MPS} \)

This equation illustrates that as the MPS increases, the multiplier decreases. This is because when people save a higher proportion of their income (i.e., when the MPS is high), less of the income is spent, and thus the initial increase in spending has a smaller effect on overall economic activity. Conversely, when the MPS is lower (meaning individuals spend a greater portion of their income), the multiplier effect is larger, leading to a greater increase in total income.

Understanding the relationship between the multiplier and MPS is crucial for policymakers, especially when making decisions about fiscal stimulus or taxation, as it helps determine the potential impact of changes in government spending on the overall economy.