Economics what is the multiplier

Multipliers are also used in explaining fractional reserve banking, known as the deposit multiplier. A multiplier is simply a factor that amplifies or increase the base value of something else.

A multiplier of 2x, for instance, would double the base figure. A multiplier of 0. Many different multipliers exist in finance and economics. The fiscal multiplier is the ratio of a country's additional national income to the initial boost in spending or reduction in taxes that led to that extra income.

An investment multiplier similarly refers to the concept that any increase in public or private investment has a more than proportionate positive impact on aggregate income and the general economy. The multiplier attempts to quantify the additional effects of a policy beyond those immediately measurable. The larger an investment's multiplier, the more efficient it is at creating and distributing wealth throughout an economy.

The earnings multiplier frames a company's current stock price in terms of the company's earnings per share EPS of stock. The equity multiplier is a commonly used financial ratio calculated by dividing a company's total asset value by total net equity. It is a measure of financial leverage. Companies finance their operations with equity or debt, so a higher equity multiplier indicates that a larger portion of asset financing is attributed to debt.

The equity multiplier is thus a variation of the debt ratio, in which the definition of debt financing includes all liabilities. One popular multiplier theory and its equations were created by British economist John Maynard Keynes. Keynes believed that any injection of government spending created a proportional increase in overall income for the population, since the extra spending would carry through the economy.

In his book, "The General Theory of Employment, Interest, and Money," Keynes wrote the following equation to describe the relationship between income Y , consumption C and investment I :. He further defined the marginal propensity to save and the marginal propensity to consume MPC , using these theories to determine the amount of a given income that is invested.

Keynes also showed that any amount used for investment would be consumed or reinvested many times over by different members of society. Because the bank is only required to maintain a portion of that money on hand to cover deposits, it can loan out the remainder of the deposit to another party. The funds spent by the construction company go to pay electricians, plumbers, roofers, and various other parties to build it. These parties then go on to spend the funds they receive according to their own interests.

Since Keynes' theory showed that investment was multiplied, increasing incomes for many parties, Keynes coined the term "multiplier" to describe the effect. This is because an injection of extra income leads to more spending, which creates more income, and so on.

The multiplier effect refers to the increase in final income arising from any new injection of spending. Marginal propensities show the proportion of extra income allocated to particular activities, such as investment spending by UK firms, saving by households, and spending on imports from abroad. The following general formula to calculate the multiplier uses marginal propensities, as follows:. As well as calculating the multiplier in terms of how extra income gets spent, we can also measure the multiplier in terms of how much of the extra income goes in savings, and other withdrawals.

This is indicated by the marginal propensity to save mps plus the extra income going to the government — the marginal tax rate mtr plus the amount going abroad — the marginal propensity to import mpm. By adding up all the withdrawals we get the marginal propensity to withdraw mpw.

The multiplier can now be calculated by the following general equation:. The multiplier concept can be used any situation where there is a new injection into an economy.

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Your Practice. Popular Courses. Economics Macroeconomics. Table of Contents Expand. What Is the Multiplier Effect? Understanding the Multiplier Effect. The Keynesian Multiplier.

Money Supply Multiplier Effect. Frequently Asked Questions. Key Takeaways The multiplier effect refers to the proportional amount of increase, or decrease, in final income that results from an injection, or withdrawal, of spending. Money supply multiplier, or just the money multiplier, looks at a multiplier effect from the perspective of banking and money supply.

What Is a Multiplier? Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.

We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms How Multipliers Impact Economics A multiplier refers to an economic input that amplifies the effect of some other variable.

Fiscal Multiplier Definition The fiscal multiplier measures the effect that increases in fiscal spending will have on a nation's economic output, or gross domestic product GDP.

Induced Taxes Induced taxes are taxes induced by changes in real economic activity that can act as automatic stabilizers on the macroeconomy.

Pushing On A String Definition Pushing on a string is a metaphor for the limits of monetary policy when households and businesses hoard cash in the face of a recession.