Question

It has been argued that Keynes's most significant contribution to macroeconomics is his development (or at least popularizing) of the concept of a multiplier—the notion that one dollar of added spending (let's say government spending) results in an increase in aggregate income of more than one dollar.

Question: What accounts for the multiplier effect? That is, why is the resulting increase in income greater than the initial increase in government spending? Stated differently, what gives the multiplier a value greater than one?

I do not want a mathematical formula here. Answer in plain English.

Answer 1

Let us consider an increase in autonomous investment worth $10,000. Assume the MPC is 0.9, therefore,

Increase in income in round 0 = $10,000

Increase in consumption in round 1 = $10,000 x 0.9 = $9,000

Increase in income in round 2 = Increase in consumption in round 1 = $9,000

Increase in consumption in round 2 = $9,000 x 0.9 = $8,100

Increase in income in round 3 = Increase in consumption in round 2 = $8,100

Increase in consumption in round 3 = $8,100 x 0.9 = $7,290,

Increase in income in round 4 = Increase in consumption in round 3 = $7,290 and so on.

Therefore, total increase in income = $10,000 + $9,000 + $8,100 + $7,290 + ...........

As is seen, every round of an increase in income gives rise to an increase in consumption, which further increases income, which further raises consumption, and so on. The process goes on until all rounds of income-consumption activities in the economy are exhausted. As a result, total increase in income is higher than initial increase in autonomous consumption. The ratio of total increase in income to initial increase in autonomous consumption (or any autonomous spending) is the spending multiplier.