The multiplier is a conceptual tool used to capture the complicated process by which changes in spending affect a nation's income. It is based on the idea that a small change in spending can bring about a much larger change in income. Consider the following example as an illustration of how the multiplier works. Suppose an individual pays a gardener $100 for a spring cleanup. The gardener saves $10 of those $100 but spends $90 at the local hardware store for new tools. Of the $90, the hardware storeowner saves nine dollars and spends $81 on a golf club. The golf storeowner spends 90 percent of the $81 ($73) to take his family out to dinner. The $100 that was originally spent was re-spent three more times and, in the process, was turned into $344 of income to others. This process continues and ultimately $100 of spending could lead to as much as $1000 of income. In that case, the multiplier would be 10. The product of that computation is known as the multiplier effect.
The multiplier effect occurs throughout the economy on an immense scale. Suppose the economy is at less than full employment. Several large firms invest in new plants, workers are hired, new wages are paid, and new profits flow to the companies. The recipients of this income will save some income and spend a portion of it on goods and services. More income is thus created for the suppliers of the goods and services. This process goes on ad infinitum and the total increase in national income ends up being many times larger than the initial investment.
The multiplier is a cornerstone of Keynesian economics, based on the theories of John Maynard Keynes (1883–1946). Developed at the time of the Great Depression (1929–1939), Keynesian economics deals with the need to stimulate aggregate, total demand to lower unemployment. The multiplier is used to estimate the impact new private investment, government spending, or tax cuts will have on national income.
The multiplier can work in both directions. For every dollar decrease in investment or spending, the level of national income will fall by much greater than one dollar. The Great Depression is an example of the multiplier in a downward cycle. By the late 1930s investment increased and the Depression ended with the mobilization of resources for World War II (1939–1945), which resulted in increased demand for goods and significant government spending. Thus, the multiplier works in a cumulative pattern, both expanding and contracting economic activity.
See also: Aggregate Demand, Keynesian Economic Theory, Supply and Demand, Unemployment
mul·ti·pli·er / ˈməltəˌplīər/ • n. a person or thing that multiplies. ∎ a quantity by which a given number (the multiplicand) is to be multiplied. ∎ Econ. a factor by which an increment of income exceeds the resulting increment of savings or investment. ∎ a device for increasing by repetition the intensity of an electric current, force, etc., to a measurable level.