Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What does the multiplier effect describe in an economy?

1. The relationship between savings and investment

2. The increase in national income resulting from an injection

3. The effect of interest rates on consumer spending

4. The impact of government regulations on income

The correct answer is: The increase in national income resulting from an injection

The multiplier effect describes how an initial increase in spending (an injection) leads to a more significant overall increase in national income. When new spending occurs, such as government investment or consumer expenditure, it generates additional income for businesses and workers. These recipients then spend a portion of their new income, which continues to flow through the economy, creating further income and spending in a cascading effect. For example, if the government invests in infrastructure, the contractors hired will pay employees and purchase materials, which leads to additional spending in those sectors. This process continues as each round of spending creates additional demand and income, amplifying the original investment's impact on the economy. This concept is crucial for understanding how fiscal policy can influence economic growth and is central to macroeconomic theory. Other options, while related to economic dynamics, do not encapsulate the essence of the multiplier effect as accurately as this description of national income increase through injections of spending.