If the marginal propensity to save is 0.8; calculate the multiplier?

A. 1.25
B. 5.00
C. 1.30
D. 2.25

Correct Answer:

Option B = 5.00

Explanation

The multiplier effect refers to the increase in final income arising from any new injection of spending. The size of the multiplier depends upon the household’s marginal decisions to spend, called the marginal propensity to consume (mpc), or to save, called the marginal propensity to save (mps).

The following general formula to calculate the multiplier uses marginal propensities, as follows:

1/(1 – mpc)

Hence, if consumers spend 0.8 and save 0.2 of every N1 of extra income, the multiplier will be:
1/(1 – 0.8)  = 5