Do you think an economy is better off having an income multiplier with respect to government spending equal to 2 or equal to 8?

1 Answer | Add Yours

pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

While there are reasons why a larger government spending multiplier is worse than a smaller one, I would say that a multiplier of 8 is better than a multiplier of 2.

In general, it is somewhat bad to have a multiplier that is too big.  This is because such a multiplier makes it harder to keep the economy stable.  If the multiplier is very large, every change in government spending has a very large impact on the economy.  If government spending goes up a relatively small amount, it could lead to a very large increase in GDP, potentially causing the economy to overheat.  If government spending declines, it could lead to a large decrease in GDP, potentially triggering a recession.  Therefore, we could argue that it is better to have a smaller multiplier.

However, I would argue that a multiplier of 2 is too small.  This is because a multiplier of 2 indicates that the marginal propensity to consume (MPC) in the economy is very low.  The multiplier is determined by the formula

Multiplier = 1/(1 – MPC)

Given this formula, we can determine that the multiplier is 2 if the MPC is .5.  This would mean that people would be spending only $.50 of each additional dollar of income that they receive.  If there was this little consumption, the economy would probably not be doing very well.

Therefore, while a very high multiplier is bad, a multiplier of 2 would tend to indicate that consumer spending is rather low, which could well be a symptom of a very weak economy.

Sources:

We’ve answered 318,911 questions. We can answer yours, too.

Ask a question