Why can €100m of government spending raise GDP by €500m?
Why €100m becomes €500m
An injection
The government pays builders €100m for a new road.
Spent again
The builders spend 80% (€80m) in shops; 20% leaks out.
And again
The shopkeepers spend 80% of their €80m: €64m.
Added up
Each round is smaller; together they reach €500m.
€100m of new spending, MPC = 0.8
| Round | New income | Spent (MPC 0.8) | Leaks: saved, taxed, imported |
|---|---|---|---|
| 1: the government spends | €100m | €80m | €20m |
| 2 | €80m | €64m | €16m |
| 3 | €64m | €51.2m | €12.8m |
| … and so on | |||
| In total | €500m | €400m | €100m |
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The size of the multiplier depends on how much leaks out each round.
The two formulas
With the MPC
Multiplier = 1 ÷ (1 − MPC) = 1 ÷ (1 − 0.8) = 5
With the leakages
Multiplier = 1 ÷ (MPS + MPT + MPM)
Germany, May 2026 paper
1 ÷ (0.05 + 0.18 + 0.19) = 1 ÷ 0.42 = 2.38
Then use it in either direction.
Using the multiplier
Change in GDP
Multiplier × change in injection: 5 × $300m = $1,500m.
Spending needed
Target rise in GDP ÷ multiplier: €160bn ÷ 2.38 = €67.2bn.
The points to remember
- Bigger leakages (saving, tax, imports) mean a smaller multiplier.
- Write the formula, then the numbers, then the answer with its units.
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On a diagram, AD shifts twice.
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The points to remember
- It works in reverse too: a €100m spending cut can lower GDP by €500m.
- In practice it is smaller: near full capacity prices rise, and crowding out cuts investment.
Remember it as: First the injection, then the rounds of spending.
Paper 1 asked this in May 2024, as part (a) for 10 marks.
Using the Keynesian multiplier, explain how an increase in government spending can result in short-term economic growth.
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How the 10 marks are given
| Marks | What your answer needs |
|---|---|
| 9–10 | Theory fully explained, terms used correctly all the way through, the diagram included and fully explained |
| 7–8 | Theory explained, terms mostly right, the diagram included and explained |
| 5–6 | Theory partly explained, some terms, the diagram included |
| 1–4 | Theory only described or stated; few relevant terms |