My tutor said that only $I$, $G$, $X-M$ in AD can include a multiplier and that consumption does not create a multiplier effect. I understand that these factors affect my ability to consume and that one of these factors changing will affect my income and affect my MPC and create a multiplier. But, what if i take a loan? am i not creating further rounds of spending? I am increasing demand and increasing retailer incomes and increasing further rounds of spending so how is it not a multiplier?

  • $\begingroup$ Hi anon, can you provide more context to your question? E.g. it seems like you're referring to the IS-LM or AS-AD models. Maybe you can also provide the equation to which your questions refers. $\endgroup$ Commented Jan 28 at 12:50

1 Answer 1


I think either you misunderstood your tutor or they were not clear.

What they likely meant was that increase in total $C$ won’t be multiplied by multiplier. I think this is best seen mathematically. I will omit X-N to simplify the math a bit and use the AD in an closed economy:

$$Y= C+I+G$$

Next what your tutor assumes implicitly is that both $I$ and $G$ are exogenously given, this is standard simplification assumption for beginners but it’s worth while noting that especially for $I$ this is generally not the case.

Next consumption depends on net income and it will be given by:

$$ C(Y-T)= c_0 +c_1 (Y-T)$$

Where $c_0$ is autonomous consumption (special type of consumption that does not depend on income) $c_1$ is marginal propensity to consume, $Y$ is the aggregate income which is macroeconomically equivalent to AD and output, finally T are taxes (taxes are sometimes also dropped to simplify things for students so maybe you were not introduced to them).

So now our model looks like this:

$$Y= c_0 +c_1 (Y-T)+I+G$$

Since $Y$ is on both sides of equation we first have to solve for $Y$ to see clearly the effect different variables have on $Y$. Using simple algebra we find:

$$Y= \frac{1}{1-c_1}\left(c_0 +I + G - c_1 T\right)$$

The fraction $\frac{1}{1-c_1}$ is the multiplier, and only variables in the bracket affect the AD via the multiplier. As you can see in bracket there is no $C$ because $C$ was endogenous and dependent on income so it is not $C$ that drives higher income/AD but higher income/AD itself. There is self reinforcing loop, although this effect gets smaller through each circle (since MPC cannot be bigger than 1).

However, what I think your tutor did not appropriately explain is that AD still depends on the autonomous portion of consumption $c_0$. So some consumption does have this effect, but if we talk about aggregate consumption $C$ then no because $C$ is ultimately driven by $Y$.

Next you are probably asking why $I$ isn’t also driven by $I$ and that’s a good question, in real life it almost certainly is, save some special circumstances like liquidity trap, but in class when you learn the model for the first time $I$ will be assumed independent of income so the model solves easier. Later on you will see that when $I$ will be dropped from the solution.


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