Government Expenditure Theories - The Multiplier - £10bn expenditure = £20bn income?

When the government increases the level of its spending, the effects will often go well beyond the spending itself. There will often be knock-on effects in the economy as well. To illustrate this, consider the example of previously unemployed workers who are taken on by the government, say as construction workers. They will now be earning significantly more money. They will almost certainly spend most of this money, and the firms that they spend it with are also therefore better off. They in turn are likely to spend some of this extra money, and so the cycle begins again............... At each stage of the cycle, the amount being passed on will become less and less. Some might not be passed on because it is saved. Some might be spent on foreign goods and so leave the country. Some will be lost in tax as the government takes its share of the extra income.

The initial increase in expenditure has therefore led to a bigger increase in the level of income of the economy. This is known as the Multiplier effect. The size of the Multiplier will depend on how much income gets passed on at each stage. If the unemployed workers were to save all their extra income, then there would be no Multiplier at all and the cycle would stop. However, if they and everyone who receives extra income spends the majority of it (on UK goods and services) then the multiplier will be much bigger.

The multiplier can therefore be worked out from the extra consumption that is generated from each increase in income. This extra consumption is measured by the marginal propensity to consume and from the MPC we can work out the multiplier.