Cambridge International as and a level Economics Ebook

Marginal propensity to save: 
the proportion of extra 
income which is saved.
KEY TERM
Three-sector economy
Th
e additional sector in this model is the government. Th
is 
gives an extra injection, 
G
(government spending) and an 
extra withdrawal, 
T
(taxation). Th
e multiplier is now:
1
mps mrt
+
where mrt is the 
marginal rate of taxation
(the proportion 
of extra income which is taxed). Equilibrium income is 
achieved where aggregate expenditure equals output, 
C
+
I
+
G
=
Y
and injections equals withdrawals, 
I
+
G
=
S
+
T
.
Marginal rate of taxation: 
the proportion of extra income 
taken in tax.
KEY TERM
Four-sector economy
Th
is is the most realistic model as it includes all four 
possible sectors (households, fi rms, the government and 
the foreign trade sector) and is an open economy. Again, 
equilibrium income is where aggregate expenditure equals 
output, but this is now where 
C
+
I
+
G
+
(
X
− 
M
) 
=
Y
, 
and injections equal withdrawals, which is now where 
I
+
G
+
X
=
S
+
T
+
M
. Th
e full multiplier is:
1
mps mrt mpm
+
+
where mpm is the 
marginal propensity to import
(the 
proportion of extra income that is spent on imports).
Marginal propensity to import: 
the proportion of extra 
income spent on imports.
KEY TERM
TOP TIP
In giving a numerical example of the multiplier, keep the 
figures simple, e.g., an mps of 0.2 rather than 0.235. You 
will be assessed on your understanding of the concept 
rather than your ability to manipulate diff icult figures.