Autonomous component of( Aggregate Demand changes) equilibrium output (Y) will change. The change in output will be even larger than the initial change in Aggregate Demand. This result for the change in Y to be greater than the initial change in Aggregate Demand is known as the multiplier effect. For example, if the marginal propensity to consume (MPC) is 0.80 and autonomous investment increases by 200, equilibrium output will ultimately change by 1,000 not 200.
(simple) output multiplier is defined as 1/(1-MPC). For example with an( MPC) of 0.80 the simple output multiplier is 1/(1-0.80) = 5 so the $200 initial increase in investment increases output by 5 x 200 = 1,000.
The simple output multiplier assumes there are no proportional taxes all expenditures are for domestically produced goods and services, and the price level is fixed
One by one we relax the assumptions we made in calculating the simple output multiplier. Let us start by introducing proportional taxes. A proportional tax is a tax that varies with the level of income. An example is the income tax. If income is taxed at a 20 percent rate then t = 0.20 where t is the tax rate. Tax revenue (T) is the total revenue collected from the tax. It is computed by the formula:
T = t × Y.
The formula for the output multiplier GIVEN BY
If MPC = 0.80, and t = 0.25, then the output multiplier is