Fiscal Policy & The Multiplier
AP Macroeconomics
http://www.econosseur.com/fiscal-policy/
Where we came from…
In a previous lesson, we
learned about the
tools embedded in the
economy that
respond to different
phases of the
business cycle.
These tools are
called “automated
stabilizers”
http://www.languageguide.org/images/im/tools.png
Why are they automatic stabilizers?
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Do we put the economy on autopilot, and leave it to the automatic
stabilizers?
They adjust without
action by Congress or
the president
They serve as
stabilizers because
they limit the increase
in real GDP during
expansions and
reduce the decrease
in real GDP during a
recession.
http://blog-pfm.imf.org/pfmblog/2009/02/whither-the-automatic-stabilizers.html
Here are some examples of automatic
stabilizers:
1) Income tax system
2) Unemployment compensation
3) Stock and bond returns
Now…
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It’s time to use these models to analyze the
effects of discretionary fiscal policy
Previously, we saw that expansionary fiscal
policy moves the AD curve to the right, and a
contractionary fiscal policy moves it to the
left.
But simply knowing the direction of a shift is
not enough.
We want to know: BY HOW MUCH!
How do we find out how much?
We use the MULTIPLIER!
When the government
chooses to implement a
fiscal policy, the initial
amount spent is not all that
counts.
Every time the government
spends, there is a chain
reaction or a ripple effect.
http://www.wix.com/blog/2012/05/3-great-reasons-to-list-prices-on-your-website/
Remind me…what is the multiplier?
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The ratio of change in real
GDP caused by an
autonomous change in
aggregate spending to the
size of that autonomous
change. 1/(1-MPC)
Any change in government
purchases of goods and
services is an example of
an autonomous change in
aggregate spending!
http://mathfour.com/arithmetic/multiplication-tricks
What about the MPC and government
spending?
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Usually, households will only
spend a portion lower of the
original amount (that is, if they
get money back in tax returns,
they will usually save some of it).
Thus, if the government
expenditure is $50 million, and
the MPC is .5, households will
only spend $25 million in the first
round, and so on.
Remember: MPC = change in
consumption/change in
disposable income!
http://weare1776.org/2084/world-news/government-spending-27-million-for-moroccan-pottery-classes-over-500-billion-for-defense/
Tax Multiplier
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Taxes affect the multiplier in
a way different than does
government spending.
Once we add taxes into the
mix, disposable income
increases much less.
Taxes reduce the size of the
multiplier.
The tax multiplier is always
negative, and is as follows:
 -MPC/(1-MPC) or –
MPS/MPS
http://www.american.com:8080/archive/2008/june-06-08/taxlessons
Discretionary Fiscal Policy
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According to Krugman, is “the
direct result of deliberate
actions by policy makers rather
than” relying on automatic
adjustment (p. 212).
A good example is during a
time of inflation, the
government may reduce the
amount of money in print and
raise the interest rate.
Another example is when,
during times of depression or
recession, the government
increases spending.
http://www.frumforum.com/the-problems-with-stiglitzs-depression/
And now…
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Some resources:
http://www.reffonomics.com/
Morton workbook Activity 32
Works Cited
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Economics of Seinfeld.
http://yadayadayadaecon.com/clip
Krugman, Paul, and Robin Wells. Krugman’s
Economics for AP. New York: Worth
Publishers.
Morton, John S. and Rae Jean B. Goodman.
Advanced Placement Economics: Teacher
Resource Manual. 3rd ed. New York: National
Council on Economic Education, 2003. Print.
Reffonomics. www.reffonomics.com.