Firms believe that the current economic downturn will be long-lasting and have decided to hold very little excess labor. The government reports that the unemployment rate is 12.5%. The government has decided to stimulate the economy by increasing government spending. In this situation the multiplier is likely to be

Question

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When firms hold little excess labor, it means that there is a low supply of labor, which can cause wages to rise. If the government increases spending, this will increase the demand for goods and services, which will prompt firms to hire more workers. This increase in employment will contribute to a further increase in demand as the newly employed workers spend their incomes. The positive feedback loop will lead to a large multiplier effect, where a small increase in spending leads to a much larger increase in GDP. Therefore, the multiplier is likely to be large in this situation.

Firms Believe That the Current Economic Downturn Will Be Long-Lasting