Module Fiscal Policy and the Multiplier

1. 21 ModuleFiscal Policyand the Multiplier • KRUGMAN'S • MACROECONOMICS for AP* Margaret Ray and David Anderson

2. What you will learnin thisModule: • Why fiscal policy has a multiplier effect • How the multiplier effect is influenced by automatic stabilizers

3. Multiplier Effects of an Increase in Government Purchases of Goods and Services • How much will the AD Curve move by a given policy? • Initial increase in spending causes a greater change in GDP • Indirect effect of increased spending: Multiplier Effect: 1/MPS • Example: If MPC = .5 Multiplier = 2 Increase Gov Spending $50 Billion Increase in GDP= $100 Billion ($50 Billion x 2)(Same effect on contractionary policy accept GDP will shrink sand economy will contract)

4. Multiplier Effects of Changes in Government Transfers and Taxes • Taxes and Transfers compared to Government Spending • A. Transfers; Tax cuts; and Taxes • Changes GDP in smaller increments due to how Households/businesses re-use the money. Usually subject to the MPC and MPS Ratios • B. Government spending is a direct injection of money to be used and multiplied in the economy • Example: Same $50 billion given to HH is subject to MPC ratios$50 billion x MPC .5= 25 billion to re-spend$25 billion x 2 multiplier= $ 50 Billion Increase in GDP

5. How Taxes Affect the Multiplier • The reliance of taxes on real GDP:Taxes lower disposable income • Effect on the multiplier: Taxes overall reduce the spending multiplier by taking money away from DI • Automatic stabilizers: Fiscal Policy in place that automatically expands when the economy is contracting or contracts when the economy is expanding without new legislation. Ex: Progressive Tax System, Changes in transfer payments (Unemployment; Food Stamps) • Discretionary Fiscal Policy: Fiscal policy that is the direct result of policy makers. Pass legislation for tax changes; government spending