Multipliers Fiscal Policy MPC MPS Multiplier Analysis MPC
- Slides: 7
Multipliers & Fiscal Policy MPC, MPS & Multiplier Analysis
MPC & MPS Importance • Size of MPC/MPS determines how far AD shifts • Fiscal Policy has a multiple affect on AD – If G↑ 1 billion => Real GDP ↑ by more than 1 billion! Price Level LRAS 1 AD 1 Real GDP SRAS 1
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 FACTOR Market Multiplier = 5 i. e. 1/MPS => 1/. 20 = 5 Change in 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
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 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 LRAS 1 AD 1 Real GDP SRAS 1
