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    Definitive Explanation of MPC, MPS & the Spending Multiplier

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    Explain the multiplier intuitively. Why is it that an increase in planned investment of $100 raises equilibrium by more than $100? Why is the effect on equilibrium finite? How do we know that the multiplier is 1/MPS?

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    Solution Preview

    When we buy something, the money does not disappear. It becomes the seller's money to spend. When he buys something, the money becomes someone else's. The same money is spent again and again, increasing total spending by more than the amount of the initial purchase.
    The effect on total spending (i.e. the effect on equilibrium) is not infinite because ...

    Solution Summary

    This solution gives a detailed explanation of the spending multiplier, including two formulas for counting it.