27 Apr Spending Multiplier
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The spending multiplier refers to the effect that increased government spending will have on a country’s economy. The term is used to indicate the fact that a small increase in government spending can result in a relatively large rise in a country’s gross domestic product (GDP).
What is the Spending Multiplier?
When the government incurs any expenditure, it puts money into the hands of the country’s citizens. Consider a situation where the government decides to spend $100 million on building a new road. This money will be used for:
What does spending multiplier mean?
- Buying road construction equipment, engineering equipment, and heavy vehicles.
- Paying wages to workers.
- Incurring other expenditure associated with the project.
- The marginal propensity to consume (MPC) is 0.75 and
- The marginal propensity to save (MPS) is 0.25.
The year 1929 saw the US economy entering into a recession. Unemployment soared, the economy contracted, and 10,000 of the country’s banks failed. What did the government do to overcome this situation? It introduced the “New Deal,” a program launched by the Roosevelt administration. The New Deal was a series of government initiatives that attempted to boost demand and get the country’s economy back on track. Some of the measures that were introduced were:
Example of the spending multiplier
- Building a series of dams along the Tennessee River. This created employment and helped to generate power for the people in the region.
- Commodity farmers were paid to leave their fields fallow, resulting in an end to agricultural surpluses and low prices.
- A number of new construction projects were launched. The government paid for building new post offices, bridges, schools, highways, and parks.
When the government makes an expenditure, the increase in a country’s GDP is much larger than the amount spent because of the effect of the spending multiplier.