Multipliers & Fiscal Policy
MPC, MPS & Multiplier Analysis
MPC + MPS = 1
• MPC + MPS = 1
Group 1: MPC = .90
Group 2: MPC = .60
If taxes were reduced, which MPC would shift AD more?
LRAS1
Price
Level
SRAS1
AD ↑ more with higher MPC
-----------
Because, in short run, C↑ more
E1
---------
P1
Y1
MPC = .60
MPS = .40
AD1
Y*
Real
GDP
Multipliers & Fiscal Policy
• Fiscal Policy has a multiplier affect on AD
– If G↑ 1 billion => Real GDP ↑ by more than 1 billion!
• Size of MPC/MPS determines how far AD shifts
– Larger the MPC => the bigger the shift!
LRAS1
Price
Level
-----------
E1
---------
P1
SRAS1
Y1
AD1
Y*
Real
GDP
Gov’t Spending & Investment
Multiplier
• Multiplier = ∆GDP / ∆ Gov’t Spending
– GDP increases more than Gov’t spending rises
• 2-ways to calculate multiplier:
1/(1-MPC)
Example:
If MPC = .80
or
(you need to know MPC or MPS)
1/MPS
1/(1-.80) = 5 or 1/.20 = 5
Multiplier & GDP
• Gov’t Spending & investment have “multiple” affect on GDP
Government raises spending $100
PRODUCT
Market
If MPC = .80
FIRMS
HOUSEHOLDS
Change in GDP:
FACTOR
Market
Multiplier = 5 i.e. 1/MPS => 1/.20 = 5
Round 1
$100.0
Round 2
$80.0
Round 3
$64.0
Round 4
$51.2
Etc…..
So a $100 ↑ => causes Real GDP ↑ $500
The Tax Multiplier
• Multiplier = ∆GDP / ∆ Taxes
• Is always smaller by 1 than spending/investment multiplier
– spending multiplier = 5 => then tax multiplier = 4
• TM = -MPC/MPS or -MPC x (spending multiplier)
• Example: $200 tax cut
Example:
MPC = .80
MPC = .80
TM = -.80 * 5 = -4
1/(1-.80) = 5
Balanced Budget Multiplier
• Always equal to 1
(regardless of size of MPC)
• Example: Government ↑ Taxes & ↑ Spending
Example:
Spending Multiplier = 10
Tax Multiplier
= 9
by 1 billion
Always a difference
of 1
G ↑ 1 billion = > Real GDP ↑ 10 billion
Tax ↑ 1 billion => Real GDP ↓ 9 billion
Net Effect: Real GDP ↑ 1 billion
Multipliers & Fiscal Policy Worksheet
Price
Level
LRAS1
AD1
Real
GDP
SRAS1