The Multiplier Effect Definition:
The Multiplier Effect suggests that an injection into the circular flow of income (or AD) leads to a larger than proportional increase in national income (GDP), than the initial amount.
The Multiplier Effect Example & Explanation:
If the UK government spends money in building a railroad (e.g. imagine the continuous spending on HS2), government spending (G) will rise, leading to an injection into the circular flow of income and a rise in aggregate demand (AD). When that happens, the construction firms/workers receiving the government spending to build the railroad will use their increased incomes to consume other goods and services. As a result, the total impact on AD is likely to exceed the original. As a result, the effect on price level (inflation), economic output and employment is likely to be more severe than expected. The key here is an increase in incomes tend to promote further consumption/investment (imagine dominos falling). However, a withdrawal from the circular flow of income can also reduce AD more than the initial impact, which can cause a negative multiplier effect.
The Multiplier Effect Notes with Diagrams/Graphs:
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The video below explains both the Multiplier Effect and the Accelerator Effect in detail.
The Multiplier Effect Multiple Choice Questions
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