AP Economics Mr. Bernstein Module 21: Fiscal Policy and the Multiplier February 11, 2015

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 T m = 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 G  AD increases  Y d increases  then taxes increase  Y d increases slow 5