The Multiplier Effect
- When injections exceed leakages, AD will increase.
- The initial increase from AD (purely from the injection) will then be followed by a further increase in AD, when the effects of the injection occur
- This is the multiplier effect – The process by which any change in a component of aggregate demand results in a greater final change in real GDP
- This is because when people spend money, the money spent becomes the income of those who sell the products, and that received income is then spent on something else…
- Some of the income will be spent, and some will leak out of the circular flow
- Hence, AD rises by more than the initial amount
- This process (rise in spending) will continue until leakages match the initial injection
- For example, if the government increases spending on education in the forms of increased wages of teachers (injection), these teachers will spend their new income on things like entertainment and holidays. The sellers of these products will then spend that money on something else, but some will leak out of the circular flow.