graph of multiplier effect explained

Multiplier Effect Explained

Quick Definition: The multiplier effect is when an increase in government spending has a greater impact on the economy than the initial amount spent.

What is the multiplier effect?

The multiplier effect is a concept in economics that describes how an injection into an economy, such as an increase in government spending, creates a ripple effect which increases employment and the output of goods and services in the economy.

How does it work?

  1. An injection occurs in the economy, such as an increase in government spending.
  2. The injection increases the aggregate demand in the economy for goods and services.
  3. The increase in demand for goods and services causes firms to employ more workers and expand output.
  4. As firms are employing more workers, more people have disposable incomes and subsequently the aggregate demand increases in the economy.
  5. The increases in aggregate demand causes firms to employ more workers and the effect continues as before.

Key terms

  • Aggregate demand – This refers to the total of all the demand in an economy. The equation for aggregate demand is: Consumption (C) + Government Spending (G) + Investment (I) + (Exports (X) – Imports (M)).
  • Economy – A system that provides goods and services.
  • Gross domestic product (GDP) – This is the total value of all goods and services produced in an economy during a set period of time.
  • Injections – Injections increase the demand for domestically produced goods and services. Injections come from investment, government spending and export sales.
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