Question

Discuss and explain what effect a reduction in the marginal propensity to consume has on the size of the multiplier.

Answer 1

A reduction in the marginal propensity to consume will cause a reduction in the multiplier. When firms increase production in response to some initial change in demand, households will increase their consumption by a smaller amount when the mpc falls.

Answer 2

Effect of a reduction in the marginal propensity to consume has on the size of the multiplier is that the multiplier also decrease. It is so because multiplier and MPC have positive relationship with each other.

e.g.

If mpc is 0.9 and decreases to 0.5 then the multiplier will be:

multiplier (K) = 1/1-MPC

In first case the multiplier will be = 1 / 1-0.9

= 10 times

In second case multiplier will be =1/1-0.5

= 2 times

 

MPC

• It is marginal propensity to consume.
• It tells about additional change in consumption with a unit change in income

Multiplier

• It is a mechanism in economics which tells that  a change in one factor can bring multiple times change in other factors.
• Investment multiplier shows the change that an initial increase in autonomous expenditure leads to in equilibrium level of output.