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What is the relationship between the aggregate supply/aggregate demand model and the multiplier model?
How is the multiplier calculated?
The multiplier is calculated as 1/(1-MPC), where MPC is the marginal propensity to consume, which is the fraction of additional income that is spent on consumption. So if MPC is 0.8, then the multiplier would be 5. This means that if there is an initial increase in spending of $100 million, it would ultimately lead to an increase in output and employment of $500 million, assuming there are no other changes in the economy.