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In an open economy, what factor can reduce the value of the multiplier?
- a)Increased government spending.
- b)Decreased exports.
- c)Increased savings.
- d)Decreased taxes.
Correct answer is option 'B'. Can you explain this answer?
Verified Answer
In an open economy, what factor can reduce the value of the multiplier...
In an open economy, an increase in imports (decreased exports) can act as a leakage from the multiplier process and reduce the value of the multiplier.
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In an open economy, what factor can reduce the value of the multiplier...
Understanding the Multiplier Effect
The multiplier effect refers to the proportionate increase in final income that results from an injection of spending. In an open economy, various factors can influence the value of the multiplier.
Role of Exports
Exports are a crucial component of aggregate demand. When exports increase, they add to the overall spending in the economy, leading to higher production, income, and employment. Conversely, a decrease in exports has a significant negative impact.
Impact of Decreased Exports
- Reduced Aggregate Demand: A decrease in exports means less demand for domestically produced goods and services. This reduction lowers overall economic activity.
- Lower Income and Employment: With decreased demand, businesses may reduce production, leading to lower income levels and potential job losses, which further dampens consumer spending.
- Weaker Multiplier Effect: As income and spending decline, the multiplier effect weakens. The initial decrease in exports leads to a smaller ripple effect throughout the economy, resulting in diminished overall economic growth.
Comparison with Other Factors
- Increased Government Spending: This tends to increase the multiplier as it injects money directly into the economy.
- Increased Savings: While this can reduce consumption in the short term, it may not directly reduce the multiplier effect as savings can lead to investment.
- Decreased Taxes: This generally increases disposable income, enhancing consumer spending and potentially increasing the multiplier.
Conclusion
Thus, among the options provided, decreased exports are the most effective way to reduce the value of the multiplier due to their direct impact on aggregate demand and overall economic activity.
The multiplier effect refers to the proportionate increase in final income that results from an injection of spending. In an open economy, various factors can influence the value of the multiplier.
Role of Exports
Exports are a crucial component of aggregate demand. When exports increase, they add to the overall spending in the economy, leading to higher production, income, and employment. Conversely, a decrease in exports has a significant negative impact.
Impact of Decreased Exports
- Reduced Aggregate Demand: A decrease in exports means less demand for domestically produced goods and services. This reduction lowers overall economic activity.
- Lower Income and Employment: With decreased demand, businesses may reduce production, leading to lower income levels and potential job losses, which further dampens consumer spending.
- Weaker Multiplier Effect: As income and spending decline, the multiplier effect weakens. The initial decrease in exports leads to a smaller ripple effect throughout the economy, resulting in diminished overall economic growth.
Comparison with Other Factors
- Increased Government Spending: This tends to increase the multiplier as it injects money directly into the economy.
- Increased Savings: While this can reduce consumption in the short term, it may not directly reduce the multiplier effect as savings can lead to investment.
- Decreased Taxes: This generally increases disposable income, enhancing consumer spending and potentially increasing the multiplier.
Conclusion
Thus, among the options provided, decreased exports are the most effective way to reduce the value of the multiplier due to their direct impact on aggregate demand and overall economic activity.
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