Macroeconomics – Fiscal Policy -The Multiplier Effect

The multiplier effect

The Multiplier Effect

Fiscal policy is the use of Government spending and taxation to influence the economy. Governments use fiscal policy to influence aggregate demand in the economy in an effort to achieve the economic objectives of price stability, full employment and economic growth.

  • The Multiplier Effect is a key concept in macroeconomics.
  • The multiplier is a ratio used to estimate total economic effect for a variety of economic activities.
  • “In economics, the fiscal multiplier is the ratio of change in national income in relation to the change in Government spending that caused it.
  • National income can change as direct result of consumer spending, private sector investment, Government or foreign export spending.
  • It is influenced by an incremental amount of spending that leads to higher consumption spending, increased income and then even more consumption. The final overall national income is greater than the initial injection that created it.
  • The ( National Income), GDP, expenditure equation: Y = C + I +G +(X – M)

where C refers to Consumption spending, I = Investment spending,

G =Government spending and X – M= Net Imports ( X=Imports, M = Imports).

The GDP is defined as the total value of all final goods and services produced in a country in a given year.

  • The multiplier effect is a tool that Governments use to stimulate aggregate demand in times of recession. It does so by spending money in order to create more jobs which will have the effect of generating more consumer spending and stimulate the economy even further.
  • It is criticized as it can create what is known as, Crowding Out effects with a consequent increase in negative externalities. “

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