1 أثر المضاعف والسياسة المالية The multiplier effect and Fiscal Policy لجزء السابعا

2 Recall: from the Silver Moon economy data we were able to determine the equilibrium level For two sectors: = 500 m. When government expenditure were added (100 m) For three sectors with no taxes: = 700 m. Y e Y e The Multiplier effect i.e, an increase in  G = 100 an increase in  Y= 200 e

AE Y(AS) AE 2(C+I+G) Y Y e e AE1(c +I ) Y Y 700 Y Y e e  Y= 200  G = 100

4 Note an increase in  Y >  G (  I) or  Y /  G > 1 This is called the multiplier effect The expenditure multiplier = ( مضاعف الإنفاق ) Change in GDP initial change in spending (AE) Multiplier effect: Chain reaction of an initial change in income and spending that leads to a greater change in final income and spending. مضاعف الاتنفاق : سلسلة من الارتفاع ( التغير ) في الدخل والإنفاق الناجمة عن الارتفاع ( التغير ) في دخل أو انفاق أولى.

5 Expenditure Multiplier in a closed economy: (a) with no taxes: Example 1: For the Silver Moon economy (MPC = 0.5), we added investment expenditure by $ 100 m. This increased spending created an equal income in the economy = $100 m. This income is partly consumed ($ 50 m) and partly saved ($50 m) according to MPC & MPS. The new consumption expenditure will create a new chain of income in the economy as follows: في اقتصاد دولة القمر الفضى ( حيث (MPC = 0.5 الارتفاع في الإنفاق الاستثمارى بمقدار 100 مليون خلق دخلا جديدا في الاقتصاد بنفس المقدار. هذا الدخل الجديد يتم استهلاك نصفه ( أي 50 مليون ) وادخار النصف الآخر. الإنفاق الاستهلاكى ( 50 مليون ) سيخلق سلسلة من الدخول كما يلي :

CC SS YY Round Note: In this example total income has multiplied by 2. $ 100 m is a direct increase in AE and the other $100 m is indirect induced additional spending.

CC SS YY Round Note: In this example total income has multiplied by 4. $ 100 m is a direct increase in AE and the other $300 m is indirect induced additional spending. Example 2: If for an other economy MPS = 0.25, and the government increased its spending by  G= $100 m. This initial increase will  Y= $100 m, leading to a chain reaction as follows:

8 Note 1: The multiplier effect increases as MPS decreases (or as MPC increases ) Why ? M = YY   MPS  Note 2: See appendix

9 Appendix Recall, at equilibrium for a simple two sectors economy: IC Y e  IC Y   Y I Y C       1 MPC Y C Y I       11 MPSMPC I Y      MPS 1 

MPC Expenditure Multiplier (M)

11 Examples : 1 – If an increase in autonomous consumption by $50 m leads to an increase in total income by $250 m. What is the value of MPC? MPS 1  a Y      MPS 1  5 1  5 4  MPC

12 Examples : 2 – If C = Y I 1 = 100 I 2 = 200  Y = ? MPS 1   5  YY  X  I YY  X   

13 Recall: from the Silver Moon economy data For three sectors with no taxes: = 700 m. When government applied a fixed tax of 100 m For three sectors with fixed taxes: = 600 m. Y e Y e Note the increase in taxes have not reduced  Y by a multiplier = 2 (though MPC = 0.5) The Tax Multiplier effect

14 The Multiplier in a closed economy: (b) with taxes: Note 2: See appendix MPS MPC  T YeYe    Note 1: M T  T on equilibrium income) why?

15 Appendix At T 1 : Y 1 e = b 1 1  (a - bT 1 + I + G) At T 2 : Y 2 e = b 1 1  (a – bT 2 + I + G)  Y e = b 1 1  ( – bT 2 + bT 1 )  Y e = b 1  (T 2 - T 1 ) b   Y e = b 1  (  T) b  MPS T Y - MPC  =   b 1  b 

16 The Expenditure Multiplier in an open economy Q: for an open economy, imports are considered a leakage from the economy. Would the effect of the expenditure multiplier in the open economy be smaller or bigger than in the case of a closed economy? MPS + MPM 1  AE YeYe   

17 The GDP gap and Fiscal policy Recall, the economy maybe below its potential output (GDP) even at a state of an equilibrium income Y e Y f Q P AS(SR) AD Y e Y f AS (LR)

18 First: If Y e < Y f there exists a deflationary gap ( فجوة ركودية ) This gap may be estimated by two methods: (1) GDP gap : Y f - Y e or (2) Expenditure gap : AE - AS at full employment Q: What policies a government can apply to reduce this gap?

19 AS Y Y e e AE 0 Y Y 0 Y Y f f GDP Gap Expenditure Gap (deflationary gap)

20 There are many policies a government can apply to reduce the deflationary gap or to generally change the real GDP and the price level. One of these policies is the Fiscal Policy. Fiscal policy: Changes in government spending (on goods & services and transfer payment) and taxes designed to influence real GDP and the price level. Government spending and taxes are tools of the fiscal policy. السياسة المالية : التغير في الانفاق الحكومي ( على السلع والخدمات و المدفوعات التحويلية ) بالإضافة للضرائب بهدف التأثير على الناتج المحلى الحقيقي و مستوى الأسعار. ان الانفاق الحكومي والضرائب تعتبر أدوات السياسة المالية.

21 If an economy is facing a deflationary gap, the government can increase its spending and/or reduce taxes : expansionary fiscal policy ( سياسة مالية توسعية ) Note: In this case a budget deficit may occur ( تحقق عجز في الميزانية ). Q: What other policies a government can apply to reduce a deflationary gap ?

22 Second: If Y e > Y f there exists an inflationary gap ( فجوة تضخمية ) This gap may be estimated by two methods: (1) GDP gap : Y f - Y e or (2) Expenditure gap : AE - AS at full employment

23 AS Y Y e e AE 0 Y Y 0 Y Y f f GDP Gap Expenditure Gap (inflationary gap)

24 If an economy is facing an inflationary gap, the government can decrease its spending and/or increase taxes : contractionary fiscal policy ( سياسة مالية انكماشية ) Note: In this case a budget surplus may occur ( تحقق فائض في الميزانية ) Q1: What other policies a government can apply to reduce an inflationary gap ? Q2: Can the government affect the GDP gap with a balanced budget ?

25 The Balanced Budget Multiplier effect First: If Y e < Y f ( deflationary gap) The government can increase both  G &  T by the same amount at the same time (  G =  T) Q: Recall, that  G &  T have the opposite effect on AD, would not an equal change in  G &  T leave AD unaffected? Second: If Y e > Y f ( inflationary gap) The government can reduce both  G &  T by the same amount at the same time (  G =  T)

26 Recall, changing  G &  T will stimulate further changes in income and spending according to the multipliers M G & M T. Recall, the impact of M G > M T (Why?) Note: M BB =  Y/ (  G=  T) = 1 always at all values of MPC ! M BB = M G + M T = 1 - b = 1 =  Y 1- b 1- b  G =  T Note:  G =  T (Same direction) equal change in  Y

27 What are the obstacles facing implementing fiscal policy? ما هي الصعوبات التي يمكن ان تواجه تطبيق السياسة المالية ؟

28 If MPC = 0.5Y e = $700mY F = $1000m What is the required change in: (1)  G (2)  T to eliminate the GDP gap? MGMG = 2 YY = Y F - Y e = 300 GG = = 150 YY  =   MTMT = TT = = -300 YY  =   Examples: 1 Answers

29 If MPS = 0.25  G = 200 m  T = 100  Y e = ? MGMG = 4 MTMT = -3 YGYG = M G X  G = 800 = 4 X  YTYT = M T X  T = -300 = (-3) X    Y = 500 Examples: 2 Answer

30 If MPC = 0.75  G = 50  T = -50  Y e = ? MGMG = 4 MTMT = -3 YGYG = = X  YTYT = = 150 (-3) X (-50)   Y = 350 Examples: 3 Answer

31 If MPC = 0.8  G = 200  T = 200  Y = ? MGMG = 5 YGYG = = X 200 YTYT = = -800 (-4) X 200   Y = 200 (a): MTMT = -4 Or (b): Since  G =  T   MBB = 1   Y =  G =  T = 200 Examples:4 Answer