1. Multipliers & Fiscal Policy
MPC, MPS & Multiplier Analysis
AD2 Y2

2. GDP Leakage Leakage to GDP: S + T + M Injections to GDP: I + G + X
Leakages - Income not passed on by consumers in the circular flow
GDP = Y = C + I + G + (X – M)
Leakage to GDP: S + T + M
(S = Savings T= taxes M = Imports)
Injections to GDP: I + G + X
(Investment, Gov’t, Exports)
In equilibrium: Leakage = Injections

3. Multipliers & Fiscal Policy
Fiscal Policy has a multiplier affect on AD
If G↑ 1 billion => Real GDP ↑ by more than 1 billion!
Size of MPC/MPS determines how far AD shifts
Larger the MPC => the bigger the shift in AD!
In the short run => consumption more powerful than savings
savings is considered leakage from GDP
BUT, Savings eventually turns into Investment

4. 3 Fiscal Policy Multipliers
Gov’t Spending & Investment Multiplier
Tax Multiplier
Balanced Budget Multiplier
= 1/MPS
= -MPC/MPS
= 1
Multipliers tell you how far AD shifts?
You can calculate ↑ R-GDP from Y1 to Y2
AD2 Y2

5. Gov’t Spending & Investment Multiplier
Multiplier = 1/MPS
GDP will increases more than Gov’t spending rises
Example: If MPC = .80
Multiplier => MPS = /.20 = 5
Example: If G ↑ $1 billion
$1B X 5 = ↑ $5 billion RGDP

6. Multiplier & GDP
Gov’t Spending & investment have “multiple” affect on GDP
Government raises spending $100
PRODUCT
Market
If MPC = .80
FIRMS
HOUSEHOLDS
Change in GDP:
Round 1 $100.0
Round $80.0
Round $64.0
Round $51.2
Etc…..
FACTOR
Market
Multiplier = 5 i.e. 1/MPS => 1/.20 = 5
So a $100 ↑ => causes Real GDP ↑ $500

7. Tax Multiplier
Is always 1 less than Gov’t spending/investment multiplier
Gov’t multiplier = 5 => tax multiplier = 4
TM = -MPC/MPS
Example: $200 tax cut MPC = .80
Example: MPC = Tax Multiplier => /.20 = -4

8. Balanced Budget Multiplier
Always equal to 1 (regardless of size of MPC)
Example: Government ↑ Taxes & ↑ Spending by 1 billion
Example: Spending Multiplier = 10
Tax Multiplier = -9
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

9. Multipliers & Fiscal Policy Worksheet
LRAS1
Price
Level
Real
GDP
SRAS1
AD1

10. Tax Cuts & MPC Group 1: MPC = .90 Group 2: MPC = .60
If taxes ↓ $1 billion, which GROUP would shift AD more?
AD ↑ more with higher MPC
Because, in short run, C↑ more
BUT, in LONG RUN
Savings turns into Investment
So I is more powerful than C
Raises full potential => LRAS ↑