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 effect in economics quantifies the increase in total income resulting from an initial spending injection. The multiplier (K) is calculated using the formula:

\(K = \frac {1}{(1 - MPC)}\)

Here, MPC represents the Marginal Propensity to Consume. Given that

\(MPC + MPS = 1\)

the multiplier can also be expressed in terms of MPS (Marginal Propensity to Save) as:

\(K = \frac {1}{MPS}\)

Initially, with an MPS of 0.4, the multiplier is:

\(K_{initial} = \frac {1}{0.4} = 2.5\)

When the MPS rises to 0.5, the new multiplier is:

\(Knew = \frac {1}{0.5}= 2\)

The decrease in the multiplier from 2.5 to 2 indicates that an increase in MPS leads to a reduction in the multiplier's size. Therefore, the multiplier's size would be decreased.

The correct answer is: The size of the multiplier would be decreased