Question

Value of MPS (Marginal Propensity to Save) is increased from 0.4 to 0.5. What would be the impact on Multiplier ?

• A. The size of the multiplier would be increased
• B. The size of the multiplier would remain the same
• C. Value of multiplier is undetermined
• D. The size of the multiplier would be decreased

Answer 1

The Correct Option is D

The multiplier is inversely related to MPS, so an increase in MPS leads to a decrease in the multiplier (Multiplier = \(\frac{1}{MPS}\)).

Answer 2

The multiplier effect in economics refers to the concept that an initial change in spending (such as investment or government spending) leads to a larger overall change in national income. The magnitude of this effect is inversely related to the Marginal Propensity to Save (MPS), which represents the fraction of additional income that is saved rather than spent.

The multiplier is calculated as:

\( \text{Multiplier} = \frac{1}{MPS} \)

This equation illustrates that as the MPS increases, the multiplier decreases. This is because when people save a higher proportion of their income (i.e., when the MPS is high), less of the income is spent, and thus the initial increase in spending has a smaller effect on overall economic activity. Conversely, when the MPS is lower (meaning individuals spend a greater portion of their income), the multiplier effect is larger, leading to a greater increase in total income.

Understanding the relationship between the multiplier and MPS is crucial for policymakers, especially when making decisions about fiscal stimulus or taxation, as it helps determine the potential impact of changes in government spending on the overall economy.