Question

If there is an initial (autonomous) decrease in spending, the eventual decline in aggregate demand will be much larger because of the

Answer 1

If there is an initial (autonomous) decrease in spending, the eventual decline in aggregate demand will be much larger because of the multiplier effect.

What is Multiplier Effect ?

The multiplier effect refers to the effect on national income and product of an exogenous increase in demand.

For example, suppose that investment demand increases by one. Firms then produce to meet this demand. That the national product has increased means that the national income has increased. Consequently consumption demand increases, and firms then produce to meet this demand.

The multiplier theory refers to when an economic factor increases, it generates a higher total of other economic variables than the increase of the initial factor. When there is an autonomous change in aggregate spending more money is spent in the economy. People will earn this money in the form of wages and profits.

Thus the national income and product rises by more than the increase in investment. The multiplier effect is greater than one.

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