Discuss and explain what effect a reduction in the marginal

Discuss and explain what effect a reduction in the marginal propensity to consume has on the size of the multiplier. How it is going to impact the effect of government policies ?

Solution

The multiplier is given by 1/(1-c) where c is the marginal propensity to consume. So now if the marginal propensity to consume falls then the denominator rises and so the multiplier declines. Thus as the marginal propensity to consume falls the multiplier falls. Government policies will thus have less of an effect on the economy. As a single increase in government spending will be multiplied fewer times across the economy as people spend less as per the mpc which is now smaller.