# What implication does the permanent income hypothesis of consumption have for the value of the multiplier in the short- and long-run?

Essay

What implication does the permanent income hypothesis of consumption

have for the value of the multiplier in the short- and long-run?

The number of times that an increase in income (ΔY) is greater than the increase in injections (ΔJ) is known as the Keynesian Income Multiplier (k).

k = ΔY/ ΔJ = 1/(mpw) = 1/(1- mpc)

The diagram (Fig.1) shows that an increase in injections (ΔJ) (e.g. a rise in government expenditure G or an increase in Investment I) shifts the injections line upwards. Consumption increases and thus the aggregate demand line AD shifts upwards and induces an increase in national income. If this increase in national income (ΔY) exceeds the initial rise in injections (ΔJ), it is referred to as the multiplier effect. The multiplier effect can be explained by the fact that if extra spending is injected into the economy, it will then stimulate further spending which in turn will stimulate yet more spending and so on.

According to the multiplier formula, k=1/(mpw)=1/(1- mpc), the size of the multiplier depends on mpc or on mpw respectively. The marginal propensity to withdraw (mpw) indicates the proportion of a rise in national income that is withdrawn. The marginal propensity to consume (mpc= ΔC / ΔY) indicates the proportion of a rise in national income spent on consumption. The bigger mpc, the smaller is mpw and vice versa since the additional sum of mpc and mpw must be equal to one.

As the mpc gives the slope of the consumption function relating consumption to national income (C= f(Y)), it is ...