Spending multiplier/Tutorials

From Citizendium
Jump to navigation Jump to search
This article is developing and not approved.
Main Article
Related Articles  [?]
Bibliography  [?]
External Links  [?]
Citable Version  [?]
Tutorials [?]
Tutorials relating to the topic of Spending multiplier.

The algebra of the spending multiplier identity

An injection of 100 currency units is assumed to be made into a circular flow of income model of the economy and that the marginal propensity to consume of its recipients is c (round 1).

Of the 100 units injected, an amount equal to 100 times c is spent (round 2)

The recipients of that amount spend the same proportion of it (round 3)

- and so on as below

expenditure     saving    
round 1 100
round 2 100c 100(1 - c)
round 3 100c2 100(1 - c)2
round n 100cn 100(1 - c)n

The total spending in the economy after n rounds is

100 + 100c + 100c2 + 100c3 ....+ 100cn

- which is a geometric progression.

It can be proved that such a geometric progression converges to the value  100/(1 - c) as n approaches infinity.

The final outcome is therefore a total expenditure in the economy that is a multiple 1/(1 - c) of the initial injection, where 1 - c is definitionally equal to the marginal propensity to save.