What does the multiplier effect in economics refer to?

The multiplier effect in economics describes how an initial change in spending—whether it be an increase in consumer spending, investment, or government expenditure—can lead to a larger overall impact on the economy. When spending increases, it creates income for businesses, which can then lead to further spending by those businesses and their employees. This cycle continues, as each round of spending generates additional income and further consumption, resulting in a total economic impact that is greater than the initial change in spending.

By understanding the multiplier effect, it becomes clear how pivotal initial spending decisions can be for stimulating economic growth. For instance, if the government invests in infrastructure, not only does it directly create jobs, but it also leads to increased demand for materials and services, thus driving further economic activity. This illustrates the cascading effect of initial spending throughout the economy.