# The simple investment multiplier

Last updated: April 2, 2021

The simple investment multiplier shows the effects of an **injection** of new
spending on the final size of a country's **national income**.

Understanding the multiplier concept is important in terms of describing
how national income changes, and how policy makers can assess the likelihood
that their policies are successful.

The general
expression is:

The cross diagram can be used to illustrate the impact of a change in investment on ‘final’ national income.

For example, if investment increases by $100bn, income (Y) will increase by $200 bn, which gives the multiplier a value of ‘2’.

What is key here is to see that the value of the multiplier depends on the **marginal propensity to save**, or 'mps' for short, which determines the gradient of the savings line.

The greater the mps, the smaller the value of the multiplier, as more leaks out of the economy following an injection of investment.
With savings line S2, the multiplier falls from 2 to 1.2.

The multiplier principle can be applied to other injections, including **exports** and **government spending**.

The multiplier (k) can be calculated by the following:

### Example

The mpc for 2019 to 2020 is:

0.6 (+50)/(+30).
This gives a multiplier of:

## The fiscal multiplier

The multiplier is an important concept in helping governments decide how much new public spending
is required to achieve a given increase in GDP. The multiplier effect
resulting from government purchases is called the fiscal multiplier.

Understanding the fiscal multiplier - that is, how much new GPD result
from a given injection of public spending - is a key element in the case for
the use of fiscal policy when an economy is going into recession - or simply
growing at a level below the long term trend rate of growth.

The size of fiscal multipliers can be estimated in a variety of ways,
including through econometric models, time series analysis and what are
called 'dynamic, stochastic general equilibrium (DSGE) models'.
['Stochastic' models are those which include a random variable in their
estimations, and hence can arrive a different outcomes each time they are
run.]

The
IMF has estimated that the multiplier effects of fiscal policy can last
for up to seven years, with around 80% of the effect occurring in the first
year, then tailing off towards zero.

##### Fiscal policy

How can fiscal policy influence aggregate demand?

Fiscal policy