Multiplier mechanism
Also called: Multiplier process · Topic: Aggregate Demand, Income Determination and the Multiplier · NCERT: Class 12, Ch 3 "Money and Banking"; Class 12, Ch 4 "Determination of Income and Employment"
Meaning
The multiplier mechanism is the round-by-round process that makes income rise by more than an initial rise in spending. Extra spending becomes extra output and income, paid out as wages, rent, interest and profit. People spend a share of this new income, equal to the marginal propensity to consume (MPC). That spending becomes someone else's income, and so on. Each round is smaller than the one before, and the rounds add up as a geometric series. k = ΔY/ΔĀ = 1/(1 − MPC) = 1/MPS. It also works in reverse: a fall in spending leads to a larger fall in income.
Example
Investment rises by 10 and MPC = 0.8. Income rises by 10, then 8, then 6.4, then 5.12, and so on. The total is 10/(1 − 0.8) = 50.
Don't confuse with
- Money multiplier: the money multiplier is about how banks create money by lending out deposits. The income multiplier is about how spending creates income.