Multipliers Fiscal Policy MPC MPS Multiplier Analysis 3

Multipliers & Fiscal Policy MPC, MPS & Multiplier Analysis

3 Types of Taxes • Progressive– Tax rate increase as income increases (tax brackets) – Example: Federal & California Income taxes • Regressive– Consumes a larger % of a low income worker’s salary – Example: Gasoline Tax, Bridge Tax • Flat – Same % for everyone – Example: Sales Tax, Some State income taxes

2019 Federal Tax Brackets

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 MPC => bigger multiplier => larger shift in AD! • 3 Multipliers for Fiscal Policy: – Gov’t Spending/Investment Multiplier: 1/MPS – Tax Multiplier: –MPC/MPS • always 1 less than Gov’t multiplier – Balanced Budget Multiplier = 1 • always 1

Multipliers in Circular Flow • If Gov’t Spending ↑ $100 => R-GDP will ↑ by ____? • Fiscal Policy has a “multiple” affect on R-GDP Government raises spending $100 PRODUCT Market If MPC =. 80 FIRMS HOUSEHOLDS FACTOR Market Multiplier = 5 i. e. 1/MPS => 1/. 20 = 5 Change in R-GDP: Round 1 $100. 0 Round 2 $80. 0 Round 3 $64. 0 Round 4 $51. 2 Etc…. . So a $100 ↑ => causes Real GDP ↑ $500

Example: ↑ Gov’t Spending $1 billion • Gov’t Multiplier = 1/MPS Example: If MPC Example: If G =. 80 ↑ $1 billion Multiplier => MPS =. 20 1/. 20 = 5 $1 B G X 5 = +$5 billion R-GDP Y 2 -Y 1 = +$5 billion R-GDP

Worksheet #1

Example: Tax Cut of 1 billion • Tax Multiplier = -MPC/MPS – Is always 1 less than Gov’t multiplier • Example: $1 billion tax cut & MPC =. 80 Tax Multiplier => -. 80/. 20 = -4 -1 billion X -4 = +4 billion in R-GDP (Y 2 – Y 1)

Balanced Budget Multiplier • Always equal to 1 (regardless of size of MPC) • Example: Government ↑ Taxes & ↑ Spending Example: Spending Multiplier = 10 Tax Multiplier = -9 G ↑ +1 billion = > Real GDP ↑ +10 billion Tax ↑ 1 billion => Real GDP ↓ -9 billion ----------------------------Net Effect: Real GDP ↑ +1 billion by 1 billion Always a difference of 1

Multipliers & Fiscal Policy Worksheet

Worksheet #2

Tax Cuts & MPC Group 1: MPC =. 90 Group 2: MPC =. 60 If taxes ↓ $1 billion, which GROUP would shift AD more? AD ↑ more with higher MPC Because, in short run, C↑ more BUT, in LONG RUN Savings turns into Investment So I is more powerful than C Raises full potential => LRAS ↑