If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Multipliers

# MPC and multiplier

The expenditure and tax multipliers depend on how much people spend out of an additional dollar of income, which is called the marginal propensity to consume (MPC). In this video, explore the intuition behind the MPC and how to use the MPC to calculate the expenditure multiplier. Created by Sal Khan.

## Want to join the conversation?

• 1. Is having a high MPC is always a good thing for the economy?

2. Can MPC be influenced by monetary or fiscal policies? In other words, how can we increase or decrease MPC? • I don't understand, wouldn't the \$1000 eventually be used up?
If you use 60% of it, then I use 60% of what you pay me, then you use 60% of what I gave you, wouldn't someone eventually run into negative numbers AKA debt? Thanks ahead of time. :) • How does inflation factor into this? I imagine that since the builder and the farmer are getting paid more, they're also producing more. But isn't there a point at which the farmer or the builder decides that prices are too high and that s/he should wait until they drop, lowering his/her MPC? • That is simply an exogenous shock and exogenous shocks can be unpredictable. What we can predict is the effect on Y after the shock. If the farmer decides to stop spending and wait for prices to fall, then he will reduce either his exogenous consumption (Co) or his Investment (I) typically. In either case Y will fall by 1/1-c * the change in either Co or Io
(the o subscript indicating that the variable is independant of income ie that part of either the builder's or the farmer's spending that is not determined by his income. In the example you gave it is determined by price ie they are waiting for the prices to drop).

Of course the farmer and builder may also decide to lower the proportion they consume at every income level (c) and raise the proportion they save of their income (whilst waiting for lower prices). In this case the c would fall and 1-c (marginal propensity to save) would rise.
• If the multiplier is 1/(1-MPC)
With an MPC of 0.8 (saving 20% of your income), this would yield a multiplier of 5. But this is way too high; most estimates of the keynesian multiplier are under 2. How can this be? • At the end of the video sal says if you spend an extra dollar in the economy givin the MPC thats what the total output would increase. But how does this plug back into Y=C+I+G+NX? Does this mean if we spend an extra \$1000 that Y would go up \$2500? • The C+I+G+NX is a short form of an expanded equation. Just considereing C,
Total C actually = Co + c (Y-T) where Y-T is your disposable income ie income after tax.
Thus part of consumption (Co) does not depend on income and part of it does c Y.
c is the marginal propensity to consume. c = delta C/delta Y. It tells us how much Consumption will change for a given change in income eg if income (Y) rises by \$1 and total Consumption changes by 60 cents then c = .6.

The reason you cant see where it plugs back in is because you are not looking at the expanded equation. If we plug it back in properly the equation becomes

Y = Co + c(Y-T) + I + G + NX.
Note - the equation is capable of being expanded further depending on assumptions eg NX may not be all exogenous and nether might tax (in fact part of total taxes commonly depends on income and part does not ie total T = non income taxes plus income taxes = To + tY

You can see using the expanded equation that if c=.6 and the change in Y is plus 1000 then initially the Y on the left side would grow by 600 but we need to then add that 600 to the Y on the right hand side so there will be further increases due to the feedback loop in the equation.
The final change in Y = 1/1-c X 1000 = 1/1-.6 * 1000 = 2500

(assuming that t = 0 ie there are no income taxes which will reduce the final change)
• While the \$1,000 end up creating \$2,500 worth of transactions in the economy don't you end up with an economy within which there's no money left to buy goods and services because each party is holding funds? • Okay so how come the answer is 2500 and not 2305.60?
When using the equation:
1000 + 0.6*1000 + 0.6^2*1000 + 0.6^3*1000 +0.6^4*1000
=2305.6 • Does the MPC "keep going forever" or eventually stop? Especially since this is such a simple economy. • If any increase in Y is divided in consumption and saving, and saving equals to investment. Then if there is an increase in spending, besides the additional consumption caused by MPC, should the saved part also goes into investment and then also increase people's income and then continuous cycle?? • I'm not quite sure whether I understood your questions completely. But here is the answer to what I understood:

Y is divided into C or S. If Y is fixed then the only way to increase C is to decrease S. A decrease in S means a decrease in Investment, which means less income for the next period. Therefore, next period's Y is decreased, which results in a decreased C next period. Hence, we again come back to our original equilibrium point. 