MPC and The Multiplier
MPC’s importance depends on the multiplier theory. The value of the multiplier—is determined by MPC. The higher the MPC, the higher the multiplier and vice-versa. The relationship between the multiplier and the propensity to consume is as follows:
- (where is )
- (where, is multiplier and
Since is the MPC, the multiplier is, by definition, equal to . The multiplier can also be derived from MPS (marginal propensity to save) and it is the reciprocal of MPS,
| (MPC) | (MPS) | (multiplier coefficient) |
|---|---|---|
| 0 | 1 | 1 |
| 1/2 | 1/2 | 2 |
| 2/3 | 1/3 | 3 |
| 3/4 | 1/4 | 4 |
| 4/5 | 1/5 | 5 |
| 8/9 | 1/9 | 9 |
| 9/10 | 1/10 | 10 |
| 1 | 0 | α |
The above table shows that the size of the multiplier varies directly with the MPC and inversely with the MPS. Since the MPC is always greater than zero and less than one (i.e. ), the multiplier is always between one and infinity . If the multiplier is one, it means that the whole increment of income is saved and nothing is spent because the MPC is zero. On the other hand, an infinite multiplier implies that MPC is equal one and the entire increment of income is spent on consumption. It will soon lead to full employment in the economy and then create a limitless inflationary spiral. But these are rare phenomenon. Therefore, the multiplier coefficient varies between one and infinity.
Read more about this topic: Marginal Propensity To Consume