The Impact of Government Expenditures on Inflation

Is it true that a given increase in government expenditures leads to a greater increase in inflation when the expenditure multiplier is large?

True, False, Uncertain

Answer:

True

Government expenditure multiplier is the increase in the gross domestic product (GDP) due to a given increase in government expenditures. An increase in government expenditure increases demand, which then increases prices, leading to inflation. Therefore, a given increase in government expenditures will lead to an increase in inflation when the expenditure multiplier is large. The expenditure multiplier is larger in economies with high marginal propensities to consume (MPCs). The MPC is the change in consumption due to a given change in income. If people spend a higher percentage of their income, then the expenditure multiplier is higher. The expenditure multiplier is equal to 1/MPS, where MPS is the marginal propensity to save. The larger the MPC, the smaller the MPS, and thus the larger the expenditure multiplier.

Therefore, it is true that a given increase in government expenditures leads to a greater increase in inflation when the expenditure multiplier is large.