The money multiplier - Essay Example

4. d. The multiplier found in this number is called the money multiplier. A money multiplier represents the change in the money supply in an economy. Money supply is the amount of money circulating in the economy in the form of dollars held by the public and in the form of demand deposits held by banks. The multiplier value 5 in this case means that this is the increase in the money supply which resulted from the increase of total number of dollars held by the people in form of their income and by the change in demand deposits in banks in form of investment.

So in effect, every time the income of the people is increased by $5, the investment in held by banks as their deposits will also be increased by $1. 6. d. Changes in the tax multiplier may affect the effectiveness of a fiscal policy. This is because the tax multiplier shows the amount of income changes as a result or response to the changes in the amount of taxes. Changing the tax rate will immediately change the level of income and consumption because even though taxes are source of incomes for the government, they are considered additional expenditures on the side of the consumers.

In this case, government’s decision on increasing the marginal tax rate will definitely decrease the level of income of the consumers. If income for the consumers will be reduced, there will also be a decrease in the level of consumption as they cut back on their level of spending. These actions will bring the level of planned expenditure in the economy at a lower level and may hinder other economic activities.