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CandleFocus Glossary Editor
The concept of Fiscal Multiplier is based on the theory of marginal propensity to consume (MPC), which states that when someone receives an increase in their income, they are more likely to spend it then save it. In this manner, a nation's economic output or gross domestic product (GDP) can be affected. A nation's fiscal multiplier will measure the effect of the increase in fiscal spending on its GDP.
In simple terms, the fiscal multiplier is a ratio of the change in GDP divided by the change in government spending. A multiplier greater than one indicates that an increase in government spending will lead to a larger, or multiplied, increase in GDP. The size of the multiplier, also known as its 'impact multiplier', depends on the MPC of the people receiving the increase in income.
For instance, if a government spends $100 million in a community, and is met with a $7million increase in the community’s GDP, the fiscal multiplier of that community is .07. This can be interpreted in that for every $1 the government spends, the community will experience a $.07 boost in GDP.
On the other hand, a government may have a fiscal multiplier less than one and this typically indicates that it is 'crowding out' private investment. When the government spends more, it crowds out investment and consumer spending by taking over some money that would have gone to the private sector. Generally, the lower the MPC is, the lower the value of the multiplier. In this instance, a decrease in government spending could ultimately increase private sector spending, leading to a rise in GDP.
In conclusion, the fiscal multiplier is an important economic tool as it can measure the effect of government spending on a nation's GDP. A nation's MPC has a large impact on the amount of the multiplier, though crowding out of private investment can also lead to a multiplier less than one.
It is important to note that higher spending, in and of itself, is not always an indicator of a healthy economy. At times, more efficient spending and more productive spending can outpace investments directed towards certain sectors. With that said, the concept of the fiscal multiplier is an integral part in understanding the full implications of governmental spending policies.
In simple terms, the fiscal multiplier is a ratio of the change in GDP divided by the change in government spending. A multiplier greater than one indicates that an increase in government spending will lead to a larger, or multiplied, increase in GDP. The size of the multiplier, also known as its 'impact multiplier', depends on the MPC of the people receiving the increase in income.
For instance, if a government spends $100 million in a community, and is met with a $7million increase in the community’s GDP, the fiscal multiplier of that community is .07. This can be interpreted in that for every $1 the government spends, the community will experience a $.07 boost in GDP.
On the other hand, a government may have a fiscal multiplier less than one and this typically indicates that it is 'crowding out' private investment. When the government spends more, it crowds out investment and consumer spending by taking over some money that would have gone to the private sector. Generally, the lower the MPC is, the lower the value of the multiplier. In this instance, a decrease in government spending could ultimately increase private sector spending, leading to a rise in GDP.
In conclusion, the fiscal multiplier is an important economic tool as it can measure the effect of government spending on a nation's GDP. A nation's MPC has a large impact on the amount of the multiplier, though crowding out of private investment can also lead to a multiplier less than one.
It is important to note that higher spending, in and of itself, is not always an indicator of a healthy economy. At times, more efficient spending and more productive spending can outpace investments directed towards certain sectors. With that said, the concept of the fiscal multiplier is an integral part in understanding the full implications of governmental spending policies.