Tourism Economics Multiplier effect

1. KEYNESIAN MULTIPLIER
EFFECTS
Let’s say you find a dollar in the street. You
now have one dollar you did not have before.
You now have an “income” of one dollar.
What can you do with that dollar?? You can
spend all of it, save all of it, or spend some of
it and save some of it. You have options!

2. KEYNESIAN MULTIPLIER
EFFECTS
• Let’s assume you decide to spend the WHOLE
dollar. Your spending of that dollar is an
EXPENDITURE for you and INCOME for the
person (entrepreneur) you traded with.

3. KEYNESIAN MULTIPLIER
EFFECTS
How much did GDP increase with this
transaction?
$1.00
(you bought “stuff”)

4. KEYNESIAN MULTIPLIER
EFFECTS
• Now what happens to that dollar in the
possession of the entrepreneur? They have
the same options you had:
Spend it or Save it.

5. KEYNESIAN MULTIPLIER
EFFECTS
Let’s assume the entrepreneur spends the
WHOLE dollar at another business.
This expenditure for the entrepreneur is now
INCOME for another entrepreneur.

6. KEYNESIAN MULTIPLIER
EFFECTS
How much did GDP increase with this
transaction?
$1.00
Does this sound familiar??

7. KEYNESIAN MULTIPLIER
EFFECTS
This “found” dollar has now purchased $2.00
worth of goods and/or services.
The original dollar appears to be cloning itself!!

8. KEYNESIAN MULTIPLIER
EFFECTS
If we repeat this pattern, it would go on
FOREVER and GDP would increase
INFINITLEY. Is this possible? Unlikely…Why?

9. KEYNESIAN MULTIPLIER
EFFECTS
People have a TENDENCY TO SAVE some
portion of each dollar they receive.
Keynes had a fancy name for this: Marginal
Propensity to Save (MPS). In layman’s terms
this means people have a TENDENCY TO SAVE
A PORTION OF EACH ADDITIONAL DOLLAR
they receive.

10. KEYNESIAN MULTIPLIER
EFFECTS
The flip side of this is people have a
TENDENCY TO SPEND (or CONSUME) some
portion of each dollar they receive.
Keynes had a fancy name for this: Marginal
Propensity to Consume (MPC). In layman’s
terms this means people have a TENDENCY
TO CONSUME A PORTION OF EACH
ADDITIONAL DOLLAR they receive.

11. KEYNESIAN MULTIPLIER
EFFECTS
• Example: If I get an additional dollar I may
consume .90 and save .10.
• My Marginal Propensity to Consume (MPC)
that dollar is then: 90%.
• My Marginal Propensity to Save (MPS) that
dollar is then: 10%.

12. KEYNESIAN MULTIPLIER
EFFECTS
• Example: If I get an additional dollar I may
consume .80 and save .20.
• My Marginal Propensity to Consume (MPC) is
then: 80%.
• My Marginal Propensity to Save (MPS) is then:
20%.

13. KEYNESIAN MULTIPLIER
EFFECTS
Do you notice a pattern?
MPC + MPS = 1.00 (or 100%)

14. KEYNESIAN MULTIPLIER
EFFECTS
• Let’s see how this works in practice.
• Assume the Government wants to increase
their spending by $10 billion dollars. Assume
that the MPC in the economy is 90% and the
MPS is 10% (remember these must equal
100%). What is going to be the effect on the
GDP when we consider the Multiplier effect
of EACH of those dollars?

15. KEYNESIAN MULTIPLIER
EFFECTS
• The Government initially spends $10 billion in
the economy to purchase goods and services.
Does the Government SAVE any of this
money? NO. They spend the whole shebang!
What is the immediate effect of this
transaction on GDP? It INCREASES by $10
billion.

16. KEYNESIAN MULTIPLIER
EFFECTS
• What is now going to happen to that $10
billion now in the hands of people in the
economy? Keynes says that people in general
will spend 90% of it and save 10%.
• So when people spend 90% of $10 billion,
how much is GDP going to increase by? $9
billion.

17. KEYNESIAN MULTIPLIER
EFFECTS
• With these initial two transactions, how much
has GDP increase by?
$10B + 9B = 19B
• Once again the original $10B has “magically”
turned into $19B in GDP .

18. KEYNESIAN MULTIPLIER
EFFECTS
• Now when people who receive the $9B, they are
going to spend 90%, or $8.1B and save 10%, or $900
Million.
• GDP is now growing again!
$10B + $9B + $8.1B = $27.1 Billion
It does not stop here. Each time the money is spent
it keeps reducing by the 90% and 10% ratio UNTIL it
gets to ZERO and GDP is some much larger number.

19. KEYNESIAN MULTIPLIER
EFFECTS
• Do you want to do all that math to arrive at
how much GDP is going to increase in the
end. I did not think so.
• Keynes came up with a simple formula to do
the math for you. Remember in the
beginning it was GOVERNMENT that started
this buying frenzy. This is very IMPORTANT to
remember.

20. KEYNESIAN MULTIPLIER
EFFECTS
TAX CUT MULTIPLIER
•Instead of Government
changing its spending, they
could change TAXES instead.