Question

Respond to and answer the following scenarios and questions:

A. In your own words, explain the concept of the multiplier.

B. Approximately 1,500 out-of-town epidemiologists attended their annual convention in June of 2017. It was the largest convention ever held in the city of Boise. The average amount spent by an out-of-town convention attendee is $280 dollars per day. Assume the convention lasts 3 days, and the marginal propensity to consume is .50. How much will businesses in Boise benefit from this conference?

C. The Army National Guard employs around 2,250 people in Idaho. Assume the average salary is $50,000. Also, assume the marginal propensity to consume is .50. What would be the economic impact of losing the Army National Guard?

Answer 1

According to Keynes the amount of spending determines the equilibrium rate of output in the economy. The equilibrium in the economy will be achieved when total spending in the economy equals to the total supply of goods and services in the economy. In this case, the inventories of the business firms will be constant and they will have no incentive to change their level of output. When the expectation of the people about the future state of the economy is pessimistic, they will cut back their spending and producers will cut back their level of production.

According to Keynes the market will fail to generate the optimum solutions as any small amount of deviation will be amplified to generate even larger amount of changes in the economy. This is called the multiplier effect of change in the economy. The multiplier effect is based on the principle that spending of one economic agent generates the income of another. As increase in income increases spending, each spending generates even more income. Thus, a small amount of spending increases the income and spending in the economy at an even larger amount. The catch is, the converse is also true.

The multiplier is the number by which the initial changes in spending in the economy gets multiplied to generate total amount of changes in the income in the economy. The multiplier is given as

            ….. (1)

Here MPC is marginal propensity to consume. The MPC gives the changes in consumption due each addition unit changes in income. In other words, this is the fraction of income that the consumer spends from each addition units of increased income. Therefore, we see that the MPC determines the size of multiplier.

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