Question

If a \(50\) billion initial increase in spending leads to a \(250\) billion change in real GDP, how big is the multiplier? LO30.5 a. 1.0 b. 2.5 c. 4.0 d. 5.0

Short answer

The multiplier is 5, corresponding to option d.

Step-by-step solution

Understand the Multiplier Formula

The formula for the spending multiplier is given by \( \text{Multiplier} = \frac{\Delta \text{GDP}}{\Delta \text{Spending}} \), where \( \Delta \text{GDP} \) is the change in real GDP and \( \Delta \text{Spending} \) is the initial change in spending.

Identify Known Values

From the problem statement, we know that the initial change in spending is \( \Delta \text{Spending} = 50 \) billion and the change in real GDP is \( \Delta \text{GDP} = 250 \) billion.

Substitute Values into Multiplier Formula

Substitute the known values into the multiplier formula: \[ \text{Multiplier} = \frac{250 \text{ billion}}{50 \text{ billion}} \]

Perform the Division

Divide 250 by 50 to find the multiplier: \[ \text{Multiplier} = 5 \]

Identify the Correct Answer

Look at the provided options to identify the correct answer based on the calculated multiplier. The multiplier is 5, which corresponds to option d.

Key concepts

Real GDP

Real Gross Domestic Product (Real GDP) is a fundamental measure used to evaluate the economic performance of a country, adjusted for inflation. It essentially serves as a more accurate measurement of a country's economy by eliminating the effects of price changes over time. This ensures that comparisons of economic activity are consistent and reliable.

Real GDP accounts for the value of all final goods and services produced within a nation in a given period, usually annually or quarterly. By using constant prices from a base year, real GDP provides a clear indication of a nation’s actual economic productivity. This is vital because it allows economists and policymakers to distinguish between genuine economic growth and growth that merely reflects inflation.

Understanding real GDP helps in making informed decisions on fiscal policies and business strategies. Stakeholders can better analyze which sectors are experiencing real growth and which might be suffering, hence guiding investment and policy measures.

Spending Multiplier

The spending multiplier effect is an economic concept that explains how an initial change in spending can lead to a larger overall change in the real GDP. This occurs because of the cyclical nature of economic activity and consumer behavior.

Here's a simplified explanation of how it works:

• When there is an increase in spending, whether it's from the government, businesses, or consumers, this spending will become income for someone else.
• This new income is then spent again, creating more income and additional spending cycles.
• Each round of spending generates additional income and output.

The formula for the spending multiplier is expressed as \[ \text{Multiplier} = \frac{\Delta \text{GDP}}{\Delta \text{Spending}} \]

In the exercise, a \(50 billion increase in spending led to a \)250 billion increase in real GDP, highlighting a multiplier of 5. This means each dollar of new spending boosts the economy by $5. Understanding the spending multiplier is crucial because it helps policymakers gauge the potential impact of fiscal policies aimed at stimulating or dampening economic activity.

Change in Spending

Change in spending is a critical component of how economic stimulants impact the broader economy. It reflects the initial alteration in financial outflows by either the public sector, businesses, or consumers.

When analyzing the economic stimulus, identifying the change in spending is the first step. In macroeconomics, even small adjustments can have significant ripple effects due to the multiplier effect. This preliminary financial shift is measured as \( \Delta \text{Spending} \), which then multiplies through the economy to effect real GDP change.

For instance, in the given exercise, the initial change in spending was $50 billion. Such changes can stem from various sources like tax cuts, increased government expenditure, or increased business investments. These actions are crucial in managing economic performance, helping alleviate recessionary pressures, or tempering inflation. By carefully monitoring and adjusting spending, governments and businesses can significantly influence overall economic health.