What does the Keynesian multiplier effect suggest?

The Keynesian multiplier effect suggests that increased spending in the economy can lead to a larger overall economic output. This concept is rooted in the idea that when an initial amount of spending occurs—typically through government expenditures, investment, or consumer spending—it can create a ripple effect throughout the economy.

For example, if the government builds a new roadway, it not only directly contributes to GDP through the construction work itself but also indirectly boosts the economy by providing jobs to workers who, in turn, spend their income on goods and services. This subsequent spending stimulates further economic activity, leading to an amplified impact on overall economic output compared to the initial expenditure.

The multiplier effect is quantified through the formula where the multiplier is typically greater than one, demonstrating that the total increase in economic output will exceed the initial amount of spending. This concept is critical for understanding fiscal policy and how strategic government spending can stimulate economic growth, especially during times of recession or economic downturns.