Finance and the Economy · Seminar 9 · Government economic policy

Why €50m of police cars adds more than €50m to demand

The government’s spending becomes someone’s income. With a marginal propensity to consume of 0.75 they spend three quarters of it, which becomes someone else’s income, and so on. The rounds shrink but they add up to the initial spend times 1 ÷ (1 − MPC). Question 3, from Business Economics (Mankiw, Taylor & Ashwin, ch. 22).

Pick an MPC, or set your own. Bars are the spending in each round; the line is the running total, which approaches the multiplier times the initial spend.
save mostspend most
€10m€100m

Multiplier

Total rise in demand

After five rounds

Reading

The algebra. G + G·MPC + G·MPC² + … is a geometric series with sum G ÷ (1 − MPC). The closer MPC is to 1, the larger the multiplier, which is why expansionary fiscal policy can move aggregate demand by more than the government spends.

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