The Spending Multiplier Effect

The following examples relate to the multiplier effect.

In each of the following situations determine the direction

and size of the change in total output and income that will

result from each change in nonincome-determined spending.

1. After several years of drought, farmers in central Illinois spend $50 million on

    irrigation equipment at a time when households do not spend 25% of

    additional income they receive.

            Change in GDP is $200 million (=4 x $50)

2.  The federal government cuts spending on the purchase of new goods and

      services by $35 billion at a time when households are not spending 40%

      of additional income they receive.

3.  Developers borrow $120 million for new home construction in a suburb of

     Denver at a time when households are spending 70% of additional income

     received.

4.  Business spending for machinery and equipment falls by $6 billion after

     predictions of a recession.  Households spend only 50% of additional

     income they receive, due to the predictions.

5.  Imports increase by $25 million at the same time exports increase by

     $20 Million. Households spend 60% of additional income received.