IB DP Economics - Unit 3 - Keynesian multiplier (HL only)-Study Notes - New Syllabus

Keynesian Multiplier (HL Only)

The Keynesian multiplier refers to the process by which an initial change in spending leads to a larger final change in national income (GDP).

Initial injection → More income → More spending → Larger increase in GDP

Explanation:

• An increase in spending creates income for others.
• Part of this income is spent again, creating further income.
• This process continues repeatedly through the economy.

Formula of the Multiplier

The simple Keynesian multiplier formula is:

$ \mathrm{k=\frac{1}{1-MPC}}$

Where:

• k = multiplier
• MPC = marginal propensity to consume

Alternative Formula (HL)

$ \mathrm{k=\frac{1}{MPS+MPT+MPM}}$

Where:

• MPS = marginal propensity to save
• MPT = marginal propensity to tax
• MPM = marginal propensity to import

Important Concepts:

Marginal Propensity to Consume (MPC)

MPC is the proportion of additional income that households spend on consumption.

MPC = Change in consumption ÷ Change in income

• Higher MPC → Larger multiplier effect.
• More spending creates more rounds of income generation.

Marginal Propensity to Save (MPS)

MPS is the proportion of additional income that households save.

MPS = Change in saving ÷ Change in income

• Saving is a leakage from the circular flow.
• Higher MPS reduces the multiplier.

Marginal Propensity to Tax (MPT)

MPT is the proportion of additional income paid in taxes.

• Taxes reduce disposable income.
• Higher MPT weakens the multiplier effect.

Marginal Propensity to Import (MPM)

MPM is the proportion of additional income spent on imports.

• Imports are leakages from the domestic economy.
• Higher MPM lowers the multiplier.

How the Multiplier Works:

• Government increases spending or investment rises.
• Firms receive more income.
• Workers receive wages and spend part of their income.
• This creates further increases in demand and output.

Economic Significance:

• Shows how fiscal policy affects GDP.
• Explains why injections can have a large impact on economic activity.
• Important in recession recovery policies.

Evaluation:

• The multiplier is smaller when leakages are large.
• If the economy is near full employment, multiplier effects may cause inflation.
• Time lags may reduce effectiveness.

Key Ideas:

• The multiplier causes a larger final change in GDP.
• Higher MPC increases the multiplier.
• Leakages reduce the multiplier effect.
• Used to explain effects of fiscal policy.