Multiplier

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    Assume AD rises because firms increase investment on machinery. To produce the new machinery firms demand more workers so wages and employment rises. Workers’ disposable income rises, consumption rises and AD rises again. Because consumers demand more goods, firms demand more workers to produce more, so wages and employment rise again. Again, workers’ disposable income rises, consumption rises and AD rises. Eventually this comes to an end. At the end, the final increase in AD is greater than the initial increase in AD.

    The higher is the marginal propensity to consume (MPC) the more consumers spend during knock-on AD effects and the higher is the multiplier.

    The multiplier may be difficult to measure because: – Econometric models must be built to estimate it, these models may be wrong, they are not 100% accurate. – Maybe data is conflicting, missing or unreliable. – The multiplier could change over time as consumers become more confident and spend more of their additional income rather than save it. – The multiplier has a time lag, it does not occur instantaneously. The multiplier takes up to 2 years to exert its full effect.

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