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
How much will the AD Curve move by a given policy?
• Initial increase in spending causes a greater change in
GDP
• Indirect effect of increased spending:
Multiplier Effect: 1/MPS
• Example:
If MPC = .5 Multiplier = 2
Increase Gov Spending $50 Billion
Increase in GDP= $100 Billion ($50 Billion x 2)
(Same effect on contractionary policy accept GDP will
shrink sand economy will contract)
Multiplier Effects of Changes in Government
Transfers and Taxes
• Taxes and Transfers compared to Government Spending
A. Transfers; Tax cuts; and Taxes
• Changes GDP in smaller increments due to how
Households/businesses re-use the money. Usually
subject to the MPC and MPS Ratios
B. Government spending is a direct injection of money
to be used and multiplied in the economy
• Example: Same $50 billion given to HH is subject to MPC ratios
$50 billion x MPC .5= 25 billion to re-spend
$25 billion x 2 multiplier= $ 50 Billion Increase in GDP
How Taxes Affect the Multiplier
The reliance of taxes on real GDP:
Taxes lower disposable income
• Effect on the multiplier: Taxes overall reduce the
spending multiplier by taking money away from DI
• Automatic stabilizers: Fiscal Policy in place that
automatically expands when the economy is contracting or
contracts when the economy is expanding without new
legislation. Ex: Progressive Tax System, Changes in
transfer payments (Unemployment; Food Stamps)
• Discretionary Fiscal Policy: Fiscal policy that is the
direct result of policy makers. Pass legislation for tax
changes; government spending