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The multiplier formula for an open economy is $$\frac{1}{MPS + MPM}$$ Assume the MPM is 0.25 and MPS is 0.15 - Leaving Cert Economics - Question 5 (a) - 2017

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The multiplier formula for an open economy is $$\frac{1}{MPS + MPM}$$ Assume the MPM is 0.25 and MPS is 0.15. (i) Explain the term multiplier. (ii) Using the for... show full transcript

Worked Solution & Example Answer:The multiplier formula for an open economy is $$\frac{1}{MPS + MPM}$$ Assume the MPM is 0.25 and MPS is 0.15 - Leaving Cert Economics - Question 5 (a) - 2017

Step 1

Explain the term multiplier.

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Answer

The multiplier is an economic concept that measures how much total national income increases in response to a given increase in investment or spending. It reflects the relationship between an initial change in spending and the resulting increase in income. When an injection of spending occurs, it gets circulated within the economy, leading to additional consumption and further income generation. In essence, the multiplier effect amplifies the initial amount introduced to the economy.

Step 2

Using the formula above calculate the size of the multiplier. Show your workings.

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Answer

To calculate the size of the multiplier, we use the formula:

Multiplier=1MPS+MPM\text{Multiplier} = \frac{1}{MPS + MPM}

Substituting the values:

Multiplier=10.15+0.25=10.40=2.5\text{Multiplier} = \frac{1}{0.15 + 0.25} = \frac{1}{0.40} = 2.5

Thus, the size of the multiplier is 2.5.

Step 3

If investment in the economy increases by €10 million, what is the increase in National Income? Show your workings.

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Answer

To find the increase in National Income, we can use the multiplier calculated above:

Increase in National Income=Investment×Multiplier\text{Increase in National Income} = \text{Investment} \times \text{Multiplier}

Substituting the values:

Increase in National Income=10 million×2.5=25 million\text{Increase in National Income} = €10 \text{ million} \times 2.5 = €25 \text{ million}

Therefore, the increase in National Income is €25 million.

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