# Multiplier effect (idea)

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The multiplier effect, the [cornerstone] of [Keynesian] [fiscal policy], states that an increase in autonomous spending (on [consumption] expenditures, [gross private domestic investment], [government spending], or [net foreign investment]) will cause a multiple growth of [aggregate demand]. Keynesian economists believe that this increase in aggregate demand will cause an equal increase in [gross national product], whereas [classical economists] believe that this increase will only lead to an increase in the [price level] ([inflation]). The multiplier is dependent on the [marginal propensity to consume]. It is best explained by example. Assuming the [marginal propensity to consume] (MPC) is 0.8; the [marginal propensity to save] (MPS) will be 0.2 because MPC+MPS=1. If Bob finds $100 buried in the ground and spends it at the local computer store, the [gross national product] will have increased by $100 through the new spending. The owner of the computer store will decide to save $20 (0.2*$100) and spend $80 (0.8*$100). The owner spends the $80 at a tailor for a suit. The increase in [disposable income] by finding $100 has yielded an increase in $180 in [gross national product]. He will save $16 (0.2*$80) and spend $64 (0.8*$80). Expanding this a few more rounds: 1: $100 ,-> $80 ,-> $64 ,-> $51.2 ,-> $40.96 2: x .8 | x.8 | x.8 | x .8 | x .8 ---- | --- | --- | ----- | ------ 3: $80 -' $64 -' $51.2 -' $40.96 -' $32.768 1: The input money 2: The MPC 3: The ouput money This continues ad infinitum. If you add the original $100 to all the outputs, you will get $500: $100 80 64 51.2 40.96 32.768 26.2144 20.97152 16.777216 13.4217728 10.73741824 + 42.94967296 == all other rounds ------------- $500 This $500 is also equal to $100 * (1/0.2) because 0.2 is the MPS and some mathematical stuff I won't explain here. It has to do with the fact that it is the sum of the infinite series $100 * 0.8^x, where x is the set of integers from 0 to positive infinity. | Existing:- cornerstone
- Keynesian
- fiscal policy
- consumption
- aggregate demand
- gross national product
- inflation
- marginal propensity to consume
- marginal propensity to consume
- marginal propensity to save
- gross national product
- disposable income
- gross national product
Non-Existing: |