Keynesian economics

The Keynesian multiplier effect posits that an initial increase in spending (such as government expenditure) leads to a larger increase in GDP. This is because the initial spending creates income for recipients, who then spend a portion of that income, creating further income for others, and so on, leading to a cumulative increase in economic output.

The multiplier effect is rooted in the concept that not all of the initial spending is saved. Instead, a portion of the income generated from the initial spending is spent on consumption. This spending generates additional income for others, who then spend a portion of that income, creating a chain reaction of spending and income generation.

The size of the multiplier effect depends on the marginal propensity to consume (MPC), which is the fraction of additional income that is spent. A higher MPC means that a larger portion of additional income is spent, leading to a larger multiplier effect. Therefore, government spending can have a significant impact on GDP, especially when the MPC is high.