Transcript Module Fiscal Policy and the Multiplier

Module 21
Fiscal Policy
and the Multiplier
KRUGMAN'S
MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• Why fiscal policy has a
multiplier effect
• How the multiplier effect is
influenced by automatic
stabilizers
Multiplier Effects of an Increase in Government
Purchases of Goods and Services
•Initial increase in spending
•Government spends $200b. AD and RGDP
increase by $200b
•Indirect effect of increased spending
•The increase in government spending leads to
increased incomes for consumers. This leads to
an increase in AD and GDP also
•Remember the multiplier
•1/1-MPC = Spending Multiplier
•Spending multiplier x $200b = total change in
AD and GDP
Multiplier Effects of Changes in Government
Transfers and Taxes
Taxes and Transfers compared to Government
Spending
•Transfer payments (unemployment insurance,
TANF) change Consumption by the change in
income x MPC
•Tax cuts change Consumption by the change in
income x MPC
The tax and transfer multiplier is
MPC/MPS
MPC Multiplier
9
10
.8
5
.75
= 1/MPS
Tax Multiplier = -MPC/MPS
This is negative if taxes increase
Tax Multiplier
Spending Multiplier
-9
-4
4 -3
.60 2.5 -1.5
.5
2 -1
The tax multiplier is always smaller than the
spending multiplier because a portion of the
change in income due to taxes is saved, reducing
the overall impact on spending.
How Taxes Affect the Multiplier
•The full multiplier effect assumes a constant level
of taxes and transfer payments regardless of
income level (lump-sum taxes)
•In reality taxes and transfer payments are based
on income levels.
•The effect is that the size of the multiplier is
reduced and the economy is automatically
stabilized.
• In contrast, discretionary fiscal policy would take
place when Congress votes to make changes
in taxes or government spending
Table 21.1 Hypothetical Effects of a Fiscal Policy with a Multiplier of 2
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers