Principles of Macroeconomics / Unit 9 MAC 0826 worked example, 60 to 90 seconds
Leakages Set the Size
The idea
Three leakages stop the circulation: saving, taxes and imports. Each is a share of an extra dollar that does not return as spending on domestic output. Build the multiplier up by adding them one at a time to the course's economy, and watch it fall.
In practice
Start with the propensity to consume at 0.75 and no other leakage. The slope is 0.75 and the multiplier is one over 0.25, which is 4. Now add the 20 percent income tax. An extra dollar of GDP yields 80 cents of disposable income and 60 cents of consumption, so the slope is 0.6 and the multiplier falls to 2.5. Now add imports at 10 percent of disposable income. Eight cents of that extra dollar leave for imports, so the slope falls to 0.52 and the multiplier falls to about 2.1.
Where people slip
The multiplier fell by nearly half between the first case and the third, and the propensity to consume never changed. Quoting a multiplier without saying which leakages are in it says almost nothing.
Your place on the trail
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