In micro, the link from my spending to your income stays invisible. In macro, that link is what moves the whole economy.
When the government pays to build a bridge, the 🧑 workers earn income. They spend most of what they earn. That spending becomes someone else's income. So spending echoes around and grows bigger than it started. The more of each won people spend, the bigger the echo. That growth factor is the multiplier in the formula below.
For example, say you spend 1,000 won on snacks at the corner 🏪 shop. The owner uses that 💰 money to buy supplies next door. The next owner spends it again somewhere else. Your 1,000 won travels around the neighborhood, getting spent again and again. The neighborhood earns far more than your first 1,000 won.
The government spends more on a bridge, and the marginal propensity to consume is .
How much does income rise in total?
The paid for the bridge becomes the workers' income, and they spend of it — . That becomes the shopkeepers' income, and of it is spent again: spending turns into income, income into spending.
Adding up every round gives . Five times the initial : income climbs from to .
Which grows income more: cutting taxes by , or raising government spending by ? ()
A tax cut of raises disposable income by , but only of it — — is actually spent in the first round; the other leaks straight into saving. Extra spending puts the full to work from round one.
So the tax cut delivers , exactly one first round less than the from spending. That is why the tax multiplier is exactly smaller in absolute value than the spending multiplier .