Calculations

Earth-Shattering Statement:

All money is either spent or saved

All money = 100% of that money

MPC + MPS = 100% or 1
- If MPC = 0.8 then MPS = 0.2
- If MPC = 0.5 then MPS = 0.5

Assume an Investment of 1,000 Euro and an MPC of 0.8

When A gets the initial investment he will received 1000, spend 800 and save 200.
When B gets the 800, he will spend 640 (i.e. 80% of what was received) and save the remainder.
C has now received 640 - he too in turn will spend 80% of that 640 and save the balance.
The process will continue until the extra amount of money being received by the next party becomes negligible. At this stage, it is said that the original investment has worked its way through the economy.

Click here to see a worked example of this process

When the process has finished, the initial extra investment of 1,000 Euros will have generated 5,000 Euros worth of Income in the economy. The initial investment has been multiplied by 5, hence we have a Multiplier of 5.

If, however, we had decided as a nation to be more thrifty and had saved 50% of any extra income we received, the MPC is much smaller, therefore the Multiplier will be much smaller too.

When A gets the initial investment he will received 1000, spend 500 and save 500.
When B gets the 500, he will spend 250 (i.e. 50% of what was received) and save the remainder.
C has now received 250 - he too in turn will spend 50% of that 250 and save the balance.

When the process has finished, the initial extra investment of 1,000 Euros will have generated 2,000 Euros worth of Income in the economy. The initial investment has been multiplied by 2, hence we have a Multiplier of 2.

This is proof that the more we save the less income is generated in the economy and the less well off, economically, the country is.

Let's make life easier for you. You do not have to go through all the stages, calculating what A and B and C etc. are getting and then totalling them at the end. There is a much easier way to establish the Multiplier - by a formula, of course.

Intrigued? To view the Formulae Page, click here

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