The Multiplier Effect

The multiplier is one of the most important and most frequently examined concepts in A-Level economics. It explains why changes in injections (investment, government spending, or exports) lead to a larger change in national income. The concept was originally developed by Richard Kahn (1931) and was then integrated into macroeconomic theory by John Maynard Keynes (1936) in The General Theory of Employment, Interest, and Money.

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The Basic Idea

When an injection of spending enters the circular flow, it does not simply add to national income once. The initial spending generates income for those who receive it. They then spend a proportion of this income (determined by the marginal propensity to consume), which becomes income for others, who also spend a proportion, and so on. Each round of spending is smaller than the last, but the cumulative effect is a change in national income that is larger than the initial injection.

A Numerical Example

Suppose the government increases spending by £100 million, and the MPC is 0.8 (people spend 80% of additional income):