Eco403 GDB No. 3 spring June 2011

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each dollar of government spending can increase the nation’s gross domestic product by more than a dollar. When higher government spending increases G.D.P., consumers respond to the extra income they earn by spending more themselves. Higher consumer spending expands aggregate demand further, raising the G.D.P. yet again. And so on. This positive feedback loop is called the multiplier effect.
Suppose a government wanted to eliminate a deflationary gap of £1000m. The increase needed in government expenditure will depend on the size of the multiplier. The problem lies in knowing the exact size of the multiplier. If the multiplier is 2, then government expenditure would have to rise by £500m. However, if the multiplier was 4, a rise of only £250m would be needed. Without knowing the precise value of the national income multiplier it is difficult to fine-tune the economy accurately.
The real level of government spending grew from £364 billion in 2000 to £488 billion in 2004 – a rise of 34%. The share of GDP taken up by government spending has also increased from 38% in 2000 to 41.4% in 2004. This significant increase in government spending has helped to maintain Britain’s short-term economic growth at a time when some components of AD (notably export demand and investment) have been weak.