When money is spent on goods and services, those that

Chapter 8, Problem 8.2.33

(choose chapter or problem)

When money is spent on goods and services, those that receive the money also spend some of it. The people receiving some of the twice-spent money will spend some of that, and so on. Economists call this chain reaction the multiplier effect. In a hypothetical isolated community, the local government begins the process by spending dollars. Suppose that each recipient of spent money spends and saves of the money that he or she receives. The values and s are called the marginal propensity to consume and the marginal propensity to save and, of course, . (a) Let be the total spending that has been generated after transactions. Find an equation for . (b) Show that , where . The number is called the multiplier. What is the multiplier if the marginal propensity to consume is ? Note: The federal government uses this principle to justify deficit spending. Banks use this principle to justify lending a large percentage of the money that they receive in deposits