Question

Suppose an economy experiences a lump-sum increase in government spending of $20 million. If the multiplier is 4.0, then according to the macroeconomic model presented in the text what will be the change in the equilibrium level of output?

Answer 1

Answer:

equilibrium level of output should increase by $80 million

Explanation:

The concept of multiplier is used to explain how an increase or decrease in the money available in the economy changes economic output. In this case you have to multiply the increase in government spending by 4 = $20 million x 4 = $80 million.

Money doesn't stand still, imagine the government gives you $100, and unless you bury it in the ground, those $100 will multiply and in this case convert to $400. The idea is not that complicated, since once you receive the money, you will spend some part of it (or all) and you will save the remaining part. Let's say you buy groceries at the supermarket and spend $75, and save $25. The owner of the supermarket (the corporation or individual) will use $60 of your $75 to pay for dairy products that were purchased before. The rest will be kept in the bank. The seller of the dairy products will in turn use a part of the $60 received to pay for gas. And then it will be turn of the gas station, its employees, etc.