Question

Describe the Keynesian "multiplier effect". That is, how does the government spending $100B ultimately cause more economic impact beyond the initial spending?

Answer 1

The Keynesian multiplier effect was introduced in the 1930s. It states that , increase in Private Expenditure, Government Expenditure or Investments will lead to increase in GDP ( Gross Domestic Product )

For instances , if the government is to spend $100B in a project, say construction of Power Plants for the purpose of generating energy and power and to enhance power distribution. Out of the money spent in the project for various requirments such as labour , material , machines and working capital , the money given out as expenses is added to another party's income in the same transaction ( for ex : wages for labour is an income for them )

With this money as income, a certain proportion is saved and a certain proportion is spent on various products offered by businesses. Now as consumption levels in the economy are high , aggregate demand for goods and services will increase. With increased aggregated demand, aggregate supply of commodities from businesses will also increase.Thus increase in government spending leads to increase in economic growth and economic welfare.  

Another hypothesis in this concept is that an economy will run at full employment levels if savings were to be 0, but this is mostly flawed and doesn't take deficit spending into account.