Explain the concept of the spending multiplier and the factors that influence its size in a closed economy.

• A. Multiplier = 0; any initial spending is absorbed completely.
• B. Multiplier = 1/(1 - MPC); bigger with higher MPC and smaller leakages; open economy reduces it due to imports.
• C. Multiplier equals 1 + MPC.
• D. Multiplier = MPC; depends only on consumption propensity.

Answer: (B)

Spending multiplier measures how much total output rises from an initial increase in autonomous spending, as the extra income is spent again and again. In a simple closed economy with no taxes or imports, each extra dollar of income is split: part is spent (MPC) and part is saved, so the total rise in income is an infinite sum that equals ΔA/(1 − MPC). That makes the multiplier 1/(1 − MPC). The bigger the MPC, the larger the share of each round is spent, so the chain of spending continues longer and the total increase in income is bigger. Leakages—savings, taxes, or imports—reduce how much is spent in each round, shrinking the multiplier. In an open economy, imports act as an additional leakage, further dampening the effect. So the statement that the multiplier is 1/(1 − MPC), grows with higher MPC and smaller leakages, and falls in an open economy due to imports, best captures how the multiplier works. The other forms—zero multiplier, 1 + MPC, or just MPC—don’t reflect the repeated rounds of spending or the role of leakages.