Final answer:
The multiplier effect refers to how an initial increase in spending results in a greater overall increase in economic activity through subsequent cycles of spending. It illustrates the amplified impact of spending on the total economic output, leading to a higher equilibrium output than the initial expenditure.
Step-by-step explanation:
The multiplier effect is an economic concept illustrating how an initial increase in spending leads to an incremental increase in total expenditure. This is because the initial expenditure creates income for others, who then go on to spend a portion of that income, thereby fueling further economic activity. For example, if the government spends an additional $100, and if 30% goes to taxes, 10% to savings, 10% to imports, and the rest is spent on domestic goods and services, this initial spending will result in more rounds of spending within the economy. Let's assume the first round of government spending is $100. After the aforementioned deductions, $53 is spent again in the domestic economy. This $53 becomes someone else's income, leading to successive rounds of spending with diminishing impacts. This cycle increases the aggregate expenditure more than the initial amount. If the end total of aggregate expenditure from the initial $100 is $213, then the multiplier is calculated as $213/$100 = 2.13. The multiplier effect demonstrates how spending is 'multiplied' through the economy, influencing the equilibrium output significantly more than the initial expenditure.