Question

What is the fiscal multiplier? What determines the size of the multiplier? How does the multiplier differ between closed and open economies?

Answer 1

Fiscal multiplier is the rate at which equilibrium output or gdp changes due to one unit change in autonomous spending.

MPC which is marginal propensity to consume determines the size of multiplier.

Multiplier= 1/(1-MPC)

Closed economy multiplier= 1/(1-MPC)

Open economy multiplier= 1/(1-mpc + mpm)

mpm is the marginal propensity to import. It is the ratio of change in imports due to change in income.

As income rises imports also rises. This reduces multiplier.

Thus closed economy multiplier is higher than open economy multiplier.