SPENDING
MULTIPLIER
(FISCAL POLICY
MULTIPLIER EFFECT, MPC& MPS
 MPC
: Marginal Propensity to Consume
- The portion (%) of additional income that is
spent. How much would you spend?
 MPS: Marginal Propensity to Save
- The portion (%) of additional income that
is saved.
- Since you can only “consume” or
“spend”…. MPC + MPS = 1
MULTIPLIER EFFECT
 $100
million dollars on a new school…
- electricians (c or s?)
- new work truck (c or s?)
- movies (c or s?)
- cell phone (c or s?)
 Money that gets dumped into store or
businesses gets multiplied, therefore…
MULTIPLIER = 1/MPS
MULTIPLIER EFFECT
 $100
Billion dollars
MPC = 80% = .8
MPS = 20% = .2
Multiplier = 1/MPS
1/.2 = 1/(2/10) = 1/(1/5) = 5
Therefore, the new amount is $500 Billion
When money is spent in the economy, that
money is multiplied.
Multiplier = 1/MPS
MPC
MULTIPLIER
MPC = .9
MPC = .8
MPC = .5
MPC = 0
- Multiply the numerator and the reciprocal of the
denominator.
- The more we spend (consume) the more multiplied
- If people are spending more, then government doesn’t have
to spend as much.
- An increase in gov’t spending DOES NOT increase the money
supply!!!
Spending Multiplier Practice
 Look
at “Unit 3” handout
 Decreasing Taxes – changes in gov’t
spending have a greater effect on AD
than changes in taxes because part of a
tax is saved.
 People only spend half a tax cut, so only
half gets multiplied.
 Practice…
GOVERNMENT SPENDING
 Assume
the MPC is .5. How much should
the gov’t increase spending to close the
gap?
 Assume the MPC is .8. How much should
the gov’t increase spending to close the
gap?
TAXES
 If
the MPC is .5 how should gov’t change
taxes to close the recessionary gap?
 If the MPC is .8 how should gov’t change
taxes to close the recessionary gap?
($40B to close the gap)
FISCAL POLICY - PROBLEMS
1.
2.
3.
Deficit Spending – if the gov’t increases
spending without increasing taxes, they will
increase the annual deficit and the national
debt.
Time Lags – Congress takes time to write,
debate, pass, and implement legislation
Crowding Out – Gov’t spending might cause
unintended effects that weaken the impact
of the policy. (Ex. Deficit spending increase
AD therefore, interest rates increase and
business investments decrease.