Final answer:
The multiplier magnifies initial spending changes into larger GDP changes, influenced by the size of leakages like taxes, savings, and imports. It's essential for evaluating fiscal policy impact.
Step-by-step explanation:
The practical significance of the multiplier is that it magnifies initial changes in spending into larger changes in GDP. One person's spending becomes another person's income, leading to additional spending and further income, thereby amplifying the cumulative impact on GDP beyond the initial increase in spending. This process is crucial in understanding the effectiveness of fiscal policy and operates both in positive and negative directions; it played a key role in discussions about the effectiveness of the Obama administration's fiscal stimulus package, the American Recovery and Reinvestment Act of 2009.
Leakages, such as taxes, saving, and imports, determine the size of the multiplier by dictating how much of each dollar leaks out of the economy. When these leakages are small, the multiplier effect is more significant, leading to a higher multiplier, while large leakages produce a smaller multiplier.