The spending and tax multipliers

Learning objectives

Define the marginal propensity to consume (MPC) and the marginal propensity to save (MPS), explain why they sum to one and calculate them from changes in disposable income and consumption

Explain the multiplier process by which an initial change in autonomous spending leads to a larger total change in real GDP through successive rounds of spending

Calculate the spending multiplier as 1/(1 − MPC) or 1/MPS and use it to find the total change in AD from a change in investment, government purchases or net exports

Calculate the tax multiplier as −MPC/(1 − MPC) and explain why a change in taxes has a smaller effect on AD than an equal change in government spending

Use the multipliers to find the change in spending or taxes needed to close a given output gap, and explain why the actual change in real GDP is smaller when the price level rises