2.4.4 The multiplier

• Open economy


  Has three areas of withdrawals: taxes, imports and savings
• Marginal propensity to withdraw (MPW)


  MPW = MPS + MPT + MPM
• If an economy has a lot of spare capacity

  SRAS is elastic and the size of the multiplier will be larger
• A small increase in AD

  Leads to a large increase in national income
• If SRAS is inelastic


  The multiplier effect is likely to be smaller than its potential
• If AD increases


  Prices will increase rather than a full increase in national income
• Higher rate of inflation


  Leads to higher interest rates
• Higher interest rates


  Discourage spending and borrowing, and encourage saving
• It is possible to have a 'reverse' multiplier
• A withdrawal of income from the circular flow of income

  Could lead to an even larger decrease in income for the economy
• Reverse multiplier


  Could decrease economic growth and potentially lead to a decline in the economy