Question

If a \(\$ 50\) billion initial increase in spending leads to a \(\$ 250\) billion change in real GDP, how big is the multiplier? a. 1.0 b. 2.5 c. 4.0 d. 5.0

Short answer

The multiplier is 5, matching option d.

Step-by-step solution

Understand the Multiplier Formula

The multiplier effect in economics is calculated using the formula: \( \text{Multiplier} = \frac{\text{Change in GDP}}{\text{Initial Change in Spending}} \). In this problem, you're given a change in GDP of \\(250 billion and an initial increase in spending of \\)50 billion.

Plug Values into the Formula

Substitute the given values into the multiplier formula: \( \text{Multiplier} = \frac{250}{50} \).

Calculate the Multiplier

Compute the division \( \frac{250}{50} = 5 \). Thus, the multiplier is 5.

Choose the Correct Option

Among the options given (1.0, 2.5, 4.0, 5.0), the calculated multiplier 5 corresponds to option d.

Key concepts

Change in GDP

The change in GDP refers to the fluctuation in the total value of goods and services produced within an economy. This change is crucial because it represents the expansion or contraction of economic activity during a specific period.
When changes occur in spending, either through increased investment or consumption, they can bring about significant alterations in GDP.

• A higher change in GDP typically indicates robust economic growth, while a lower change suggests stagnation or decline.
• Understanding GDP changes helps policymakers and economists gauge the overall health of an economy and make informed decisions.

In the context of the multiplier effect, the change in GDP is crucial as it measures the ripple effect of an initial change in spending throughout the economy.

Initial Change in Spending

Initial change in spending represents the initial amount of money injected or withdrawn from an economy, often through government spending, investment, or consumer expenditure.
This initial spending can set off a chain reaction in the economy, leading to larger changes in GDP.

• For example, when the government invests in infrastructure, it initially spends money on resources and labor. This increases income for workers, who then spend their earnings on goods and services, further stimulating the economy.
• Conversely, a reduction in spending can slow down economic activity and reduce GDP.

The initial change in spending serves as the starting point for calculating the multiplier, which helps predict the total impact of that spending on GDP over time.

Economic Formula

The economic formula used to calculate the multiplier is a crucial tool for understanding the broader impacts of spending changes on an economy.
The formula for the multiplier effect is given by:
\[\text{Multiplier} = \frac{\text{Change in GDP}}{\text{Initial Change in Spending}}\]
This simple formula reveals how an initial change can, through rounds of spending, result in multiplied effects in the overall economy.

• The numerator, change in GDP, captures the total economic boost received from the spending.
• The denominator, initial change in spending, indicates the primary injection into the economic system.

By calculating the multiplier, economists can estimate how effectively an economy turns initial spending into overall GDP growth, thus serving as a critical measure of economic vitality and resilience.