Module Fiscal Policy and the Multiplier KRUGMAN'S MACROECONOMICS for AP* 21 Margaret Ray and David Anderson

What you will learn in this Module : Why fiscal policy has a multiplier effect How the multiplier effect is influenced by automatic stabilizers

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)

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

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