Which term describes the effect that government spending has on subsequent rounds of spending by others?

Which term describes the effect that government spending has on subsequent rounds of spending by others?

• A. Multiplier effect
• B. CPI
• C. Deficit spending
• D. Recession

Answer: (A)

The multiplier effect is the idea that an initial government spending injection sets off a chain of spending by others. When the government pays for something, income is earned by workers and businesses. Those recipients don’t save all of it; they spend a portion on goods and services. That spending becomes income for others, who also spend a portion, and so on. Each round of spending generates more economic activity, so the total increase in GDP can be larger than the initial outlay. How big that ripple is depends on how much of income is spent versus saved or leaked to taxes and imports. In a simple closed economy with no taxes or imports, the total impact equals the initial amount times 1/(1−MPC). For example, with an MPC of 0.8, the initial $100 could generate up to about $500 in total economic activity. The other terms aren’t about this cascading effect: CPI measures average price changes over time, deficit spending refers to financing spending with debt, and recession is a period of economic decline.

The multiplier effect is the idea that an initial government spending injection sets off a chain of spending by others. When the government pays for something, income is earned by workers and businesses. Those recipients don’t save all of it; they spend a portion on goods and services. That spending becomes income for others, who also spend a portion, and so on. Each round of spending generates more economic activity, so the total increase in GDP can be larger than the initial outlay.

How big that ripple is depends on how much of income is spent versus saved or leaked to taxes and imports. In a simple closed economy with no taxes or imports, the total impact equals the initial amount times 1/(1−MPC). For example, with an MPC of 0.8, the initial $100 could generate up to about $500 in total economic activity.

The other terms aren’t about this cascading effect: CPI measures average price changes over time, deficit spending refers to financing spending with debt, and recession is a period of economic decline.