Final answer:
The expenditure multiplier reflects how an initial increase in spending results in a greater overall impact on GDP. The multiplier effect is influenced by 'leakages'—income not spent on domestic consumption—and is crucial for understanding fiscal policy effectiveness and guiding government interventions to stabilize the economy.
Step-by-step explanation:
The expenditure multiplier is a concept in economics that describes how an initial change in spending can lead to a larger change in the overall economic output, or gross domestic product (GDP). This happens because one person's spending becomes someone else's income, which in turn leads to more spending and income, amplifying the initial impact. The size of the multiplier depends on various factors, primarily the proportion of additional income that is not spent on domestic consumption, and is instead saved, taxed, or spent on imports, known as leakages.
When leakages are small, the multiplier effect is more significant because less of the additional income is withdrawn from the circular flow of the economy. However, large leakages result in a diminished multiplier effect. It is important to note that the multiplier can have both positive and negative effects. For example, during the Great Depression, a decrease in investment led to a much larger decrease in real GDP due to the negative multiplier effect.
The Keynesian policy intervention illustrates the application of the multiplier, suggesting that government spending should be adjusted to counteract economic fluctuations. For instance, to achieve a $100 increase in real GDP, if the multiplier is 2.13, the government would need to increase its spending by approximately $47, which would then result in the desired overall GDP increase when taking the multiplier effect into account.