Newsletter Subscribe
Enter your email address below and subscribe to our newsletter
What is the Keynesian Multiplier?
The Keynesian Multiplier is an economic concept that explains how an initial increase in spending leads to a larger overall increase in national income. It reflects the idea that one person’s spending becomes another person’s income, creating a ripple effect throughout the economy.
Definition
The Keynesian Multiplier measures the ratio of the total change in economic output to an initial change in spending.
Key Takeaways
- Shows how spending stimulates economic activity.
- Central to Keynesian fiscal policy.
- Depends on how much people save versus spend.
Understanding the Keynesian Multiplier
When governments or businesses increase spending, recipients of that spending use part of the income to consume goods and services. The recipients of that spending then do the same, causing repeated rounds of expenditure.
The size of the multiplier depends largely on the marginal propensity to consume (MPC)—the proportion of additional income that households spend rather than save. A higher MPC leads to a larger multiplier effect.
The multiplier explains why fiscal stimulus, such as public infrastructure projects or tax cuts, can have an outsized impact on economic growth during downturns.
Formula (If Applicable)
The basic Keynesian Multiplier formula is:
Multiplier = 1 / (1 − MPC)
Where:
- MPC = Marginal Propensity to Consume
Real-World Example
If a government spends P100 million on infrastructure and the MPC is 0.8, the multiplier is 5. The total increase in national income could reach P500 million after multiple rounds of spending.
During recessions, stimulus packages rely on the multiplier effect to revive demand and employment.
Importance in Business or Economics
The Keynesian Multiplier helps policymakers estimate the potential impact of fiscal interventions. It informs decisions about government spending, taxation, and stimulus design.
For businesses, understanding multiplier effects helps anticipate changes in demand following public or private investment.
Types or Variations
- Spending Multiplier: Based on government expenditure.
- Tax Multiplier: Measures the impact of tax changes.
- Balanced Budget Multiplier: Occurs when spending and taxes increase equally.
Related Terms
- Keynesian Economics
- Fiscal Policy
- Aggregate Demand
- Marginal Propensity to Consume (MPC)
Sources and Further Reading
Quick Reference
- Core Idea: Spending creates amplified economic impact.
- Primary Driver: Marginal propensity to consume.
- Impact: Guides fiscal stimulus policy.
Frequently Asked Questions (FAQs)
Is the Keynesian Multiplier always large?
No, it is smaller when saving, taxes, or imports are high.
Does the multiplier work in all economies?
It works best when there is spare capacity and unemployment.
Can the multiplier be less than 1?
Yes, in cases of high leakage from the spending cycle.
