Question

If a \(50 billion initial increase in spending leads to a \)250 billion change in real GDP, how big is the multiplier?

1. 1.0

2. 2.5

3. 4.0

4. 5.0

Short answer

Option (d): 5.0

Step-by-step solution

Meaning of the multiplier

A multiplier measures the rate of change in income induced by the change in any of its expenditure components (consumption, investment, and government expenditure).An increase in income is equal to a proportional increase in the respective spending component. This proportion that causes a change in income is called a multiplier.

The following formula gives the multiplier effect of change in expenditure:

$$\begin{gathered} △Y=k\times △Expenditure \\ k=\frac{△Y}{△Expenditure} \end{gathered}$$, where k is the multiplier.

Calculating the multiplier

Given: The change in income is $250 billion, and the change in total spending is $50 billion.

k = 250/50

k = 5

Therefore, the multiplier value is 5.0.