AP Economics
Mr. Bernstein
Module 21:
Fiscal Policy and the Multiplier
February 2016
AP Economics
Mr. Bernstein
Fiscal Policy and the Multiplier
• Objectives - Understand each of the following:
• Why Fiscal Policy Has a Multiplier Effect
• How the Multiplier Effect is influenced by Automatic
Stabilizers
2
AP Economics
Mr. Bernstein
Multiplier Effect of an Increase in Government
Purchases of Goods and Services
• MPC = .90; so spending multiplier M = 1 / (1-.9) = 10
• Increase G by $50b leads to $50b x 10 = $500b
increase in AD
• Decrease in G works similarly
• Recent example: The Sequester
3
AP Economics
Mr. Bernstein
Multiplier Effect of Changes in Government
Transfers and Taxes
• MPC = .90; so spending multiplier = 1 / (1-.9) = 10
• Reducing Income Taxes by $10b leads to $10b x .9
= $9b increase in new spending, which then
multiplies into $9b x 10 or $90b increase in AD
• Tax Multiplier Tm = MPC*M = MPC/(1-MPC)
• Increase in Transfers works similarly
• Recent example: Reduction in SNAP
4
AP Economics
Mr. Bernstein
Automatic Stabilizers
• Government spending and taxation rules that cause
fiscal policy to be automatically expansionary when
the economy contracts and automatically
contractionary when the economy expands, without
requiring any deliberate action by policy makers
• Progressive tax rates
• AKA “Non-discretionary” fiscal policy
• Example: Increase G4 AD increases4 Yd increases4
then taxes increase4 Yd increases slow
5