The expenditure multiplier is used to determine how a change in spending in an economy impacts Real GDP (through expenditures).
This goes with any element of the Expenditure Approach!
GDP = Consumption + Gross Investment + Government Purchases + Net Exports
Scenario: Country ABC has an MPC value of 0.75. What its expenditure multiplier?
Expenditure multiplier = 1 / (1 - MPC)
...or...
Expenditure multiplier = 1 / MPSv
MPC = 0.75
Expenditure multiplier = 1 / (1 - 0.75)
Expenditure multiplier = 1 / (0.25)
Expenditure multiplier = 4
Answer: For every $1 in additional spending within Country ABC, the Real GDP (through expenditures) increases by $4.
When we increase expenditures in an economy (typically by government spending), it leads to more income for the members of the economy.
The members will in-turn expend (or spend) a portion of their new income (MPC)... which will result in more income for other members of the economy.
This results in a "multiplier" effect on Real GDP! The expenditures build upon each other beyond the initial expenditure!
Scenario: Country ABC increases their government spending by $100. Given an MPC value of 0.75, how much will this change in government spending increase the Real GDP?
Change in Real GDP = Expenditure multiplier x Change in Expenditures
Change in Expenditures = $100
MPC = 0.75
Expenditure multiplier = 1 / (1 - MPC)
Expenditure multiplier = 1 / (1 - 0.75)
Expenditure multiplier = 1 / (0.25)
Expenditure multiplier = 4
Change in Real GDP = 4 x $100
Change in Real GDP = $400
Answer: The government increasing their spending by $100 results in the Real GDP increasing by $400.
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