A2 Multiple-Choice Revision – the Multiplier

Below is a type of question which has been quite popular in the last couple of exam sessions. I have changed the data from the original CIE question.

The table shows the values of selected macroeconomic variable over a two-year period.

What is the value of the multiplier?

A. 3 – B. 4 – C. 6 – D. 12

From the data both years are in equilibrium
Year 1 NI = 3800  –  Injections = 260+160+200 = 620 Withdrawals = 300+140+180 = 620
Year 2 NI = 4600  –  Injections = 360+210+250 = 820 Withdrawals = 350+210+260 = 820

The increase in injections has been 200 but the increase in NI has been 800 (4600-3800) – therefore the multiplier is 4 – (4 x 200 = 800).

The Multiplier
Consider a \$300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then \$180m will be added to the incomes of others. At this point, total income has grown by (\$300m + (0.6 x \$300m). The sum will continue to increase as the producers of the additional goods and services realise an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be (\$300m + (0.6 x \$300m) + (0.6 x \$180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation ­1 ÷ (1-MPC)
You can also use the following formula which represents a four sector economy
1 ÷ MPS+MRT+MPM