The Multiplier Effect is the way that money ripples through the economy when a government provides either tax breaks or spends money. Proponants of government spending use the calculation of the multiplier effect to prove that spending is a more effective way in increase GDP than tax breaks. The quantitative effect of government spending or tax cuts is determined by using the marginal propencity to consume (MPC) and the marginal propencity to save (MPS). In theory, the multiplier is infinite. However, people tend to save at least a small portion of their increased earnings, stemming the multiplication. How much they spend in relation to how much they save is called their "Marginal Propensity".

The Output in a tax break is determined by multiplying the tax break by MPC/MPS

The Output of spending is determined by multiplying the spending increase by 1/MPS

The multiplier effect is a tool used by governments to attempt to stimulate aggregate demand. This can be done in a period of recession or economic uncertainty. The money invested by a government creates more jobs, which in turn will mean more spending and so on.

It can help prove that the lower the multiplier effect, the higher the leakages (taxes, imports, and savings) of any given increase in government, investment, or export expenditure. In other words, the higher the MPC, the higher the value of the multiplier.

A good example of the Multiplier Effect in Developmental Economics is Foreign Direct Investment. When foreigners invest in a business in a developing country more workers are needed to labor in the factories. These workers will need nearby accessible housing built, and both the factory workers and workers building housing will need food to eat.

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