Model Answer
0 min readIntroduction
The multiplier effect is a fundamental concept in macroeconomics, representing the magnified impact of an initial change in autonomous spending (like government expenditure or investment) on overall national income. It arises because one person’s spending becomes another’s income, leading to further spending and so on. The size of the multiplier is determined by the marginal propensity to consume (MPC), marginal propensity to save (MPS), and the tax rate. If a public campaign successfully persuades individuals to increase spending or investment, it can significantly alter these determinants, thereby influencing the economy’s multiplier.
Understanding the Multiplier Effect
The multiplier (k) is calculated as: k = 1 / (1 - MPC), or alternatively, k = 1 / (MPS). In a more realistic scenario including taxes, the formula becomes: k = 1 / (1 - MPC(1-t)), where 't' represents the tax rate. A higher MPC and a lower tax rate lead to a larger multiplier, indicating a greater impact of initial spending on national income.
Determinants of the Multiplier
- Marginal Propensity to Consume (MPC): The proportion of an additional unit of income that households spend rather than save.
- Marginal Propensity to Save (MPS): The proportion of an additional unit of income that households save. (MPC + MPS = 1)
- Tax Rate (t): The proportion of income paid as taxes. Higher tax rates reduce disposable income and thus lower the multiplier.
- Import Propensity: The proportion of income spent on imports. Higher import propensities reduce the domestic multiplier effect.
- Leakages: Any factor that reduces the amount of new income that is re-spent in the economy (e.g., savings, taxes, imports).
Impact of a Persuasive Campaign on the Multiplier
Assuming the public is persuaded by a campaign – for example, a campaign encouraging increased consumer spending or business investment – several effects on the multiplier are possible:
1. Increased MPC
A successful campaign directly aims to increase the MPC. If people are convinced to spend more of their income (perhaps due to increased confidence in the economy or a desire to support domestic businesses), the MPC rises. For instance, a campaign promoting “Made in India” goods could encourage consumers to prioritize domestic purchases, increasing the MPC. A higher MPC directly translates to a larger multiplier.
2. Reduced MPS (Indirectly)
As the MPC increases, the MPS necessarily decreases (since MPC + MPS = 1). This reduction in MPS further amplifies the multiplier effect. The campaign doesn’t directly target savings, but by encouraging spending, it indirectly reduces the proportion of income saved.
3. Impact on Tax Revenue & Government Spending (Potential Feedback Loop)
Increased spending due to the campaign leads to higher economic activity and, consequently, increased tax revenue for the government. The government could then use this increased revenue to fund further public spending (e.g., infrastructure projects), creating an additional boost to the multiplier. However, this is a secondary effect and depends on government policy.
4. Impact on Investor Confidence & Investment (Capital Multiplier)
If the campaign also targets business investment, it can boost investor confidence. Increased confidence leads to higher investment spending, which has its own multiplier effect (the capital multiplier). The capital multiplier is generally larger than the consumption multiplier due to the potential for further rounds of investment.
5. Addressing Leakages – Import Propensity
A campaign promoting domestic goods can also reduce the import propensity, keeping more spending within the domestic economy and further increasing the multiplier. This is particularly relevant for developing economies heavily reliant on imports.
Potential Limitations & Considerations
The effectiveness of the campaign is crucial. If the campaign fails to persuade the public, the impact on the multiplier will be negligible. Furthermore, the multiplier effect assumes that there is spare capacity in the economy. If the economy is already operating at full capacity, increased demand may simply lead to inflation rather than increased output. Finally, rational expectations theory suggests that if individuals anticipate the campaign's effects, they may adjust their behavior accordingly, mitigating the impact on the multiplier.
Conclusion
In conclusion, a successful public campaign persuading individuals to increase spending or investment can significantly enhance the economy’s multiplier. This is primarily achieved through an increase in the marginal propensity to consume and potentially a reduction in the import propensity. However, the magnitude of the effect depends on the campaign’s effectiveness, the economy’s capacity, and the potential for inflationary pressures. Policymakers must carefully consider these factors when designing and implementing such campaigns to maximize their impact on economic growth.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.