1. Chapter 7 Multipliers, Government Budgets and Net Exports
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

2. Slides prepared by Muni Perumal, University of Canberra, Australia
Learning Objectives
Analyse the impact of changes in the level of investment on equilibrium real GDP, income and employment—the multiplier effect.
Discuss the rationale for the presence of the multiplier.
Examine the difference that may exist between the equilibrium level of output and that corresponding to the full-employment level of output.
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

3. Learning Objectives (cont.)
Discuss the nature of recessionary and inflationary gaps.
Analyse the impact of government purchases and taxes on equilibrium GDP.
Introduce the macroeconomic effects of foreign trade on equilibrium GDP.
Apply our model to explain the concept of the balanced-budget multiplier.
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

4. Slides prepared by Muni Perumal, University of Canberra, Australia
Equilibrium GDP
Fluctuates widely
Investment and consumption of durables is inherently unstable
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

5. Autonomous Expenditure Changes
Shifts in the AE curve due to changes in autonomous expenditure
result in new equilibrium levels of output (GDP)
how much output changes by depends on the size of the expenditure multiplier
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

6. Expenditure Multiplier
A change in autonomous expenditure results in a change in equilibrium income that is a multiple of the initial change
The multiplier is defined as the ratio of the change in GDP arising from a change in autonomous spending
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

7. Changes in Equilibrium GDP and the Multiplier
(C + I ) 1
(C + I ) 0
510
490
470
450
430
Equilibrium GDP
at I1 level of investment
Private spending (billions of dollars) 45 o
Real GDP I1
If I
increases... S
Saving and investment
(billions of dollars) 20 I0
Real GDP
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

8. Changes in Equilibrium GDP and the Multiplier
510
490
470
450
430
(C + I ) 0
(C + I ) 2
Private spending (billions of dollars)
Equilibrium GDP
at I2 level of investment 45 o
Real GDP
Saving and investment
(billions of dollars) I2
If I
decreases... S 20 I0
Real GDP
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

9. Slides prepared by Muni Perumal, University of Canberra, Australia
The Multiplier Effect
A change in autonomous spending gives rise to a larger change in GDP
The multiplier effect arises because initial increase in aggregate expenditure will induce successive rounds of increased expenditure
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

10. Multiplier and Marginal Propensities
A relationship exists between the MPS (the amount of leakage) and the multiplier
Multiplier = 1/MPS = 1/(1 – MPC)
The simple multiplier is defined as 1/MPS, when the leakage in the economy is only saving
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

11. Slides prepared by Muni Perumal, University of Canberra, Australia
Recessionary Gap
The amount by which aggregate expenditures are deficient to that required to generate the full employment level of GDP
Produces a concretionary impact upon the economy
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

12. Recessionary Gap (cont.)
(C + I )0
(C + I )1 }
Recessionary
Gap
spending (billions of dollars)
Private
Full Employment 45 o
Real GDP (billions of dollars)
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

13. Slides prepared by Muni Perumal, University of Canberra, Australia
Inflationary Gap
Is the amount by which aggregate spending exceeds that required to achieve full employment
Produces an inflationary effect on the economy
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

14. Inflationary Gap (cont.)
(C + I )1 {
Inflationary
Gap
(C + I )0
spending (billions of dollars)
Private
Full Employment 45 o
Real GDP (billions of dollars)
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

15. Discretionary Fiscal Policy
Deliberate manipulation of taxes (T ) and spending (G ) by government for the purpose of altering real GDP and employment, controlling inflation and stimulating economic growth
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

16. Government Purchases (G)
Added to AE
Changes to autonomous government expenditure impact equilibrium real GDP through the multiplier
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

17. Three-Sector Equilibrium
C + I + G = real GDP
and
S = I + G
where
C is after-tax consumption
S is after-tax saving
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

18. Government Expenditure and Equilibrium GDP
spending
$20 billion
C + I + G
C + I C
(billions of dollars)
C + I + G 45 o
Real GDP
(billions of dollars) S 40 20
I + G
(billions of dollars)
S, I + G I
Real GDP
(billions of dollars)
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

19. Taxes and Equilibrium GDP
Taxes are assumed to be lump-sum
A tax that collects the same amount at each level of GDP
Reduces levels of both saving and consumption
How much S and C are affected depends on the MPC and MPS
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

20. Taxes and Equilibrium GDP (cont.)
C + I + G
$15 billion
decrease in
consumption
Ca + I + G
(billions of dollars)
C + I + G 45 o
Real GDP
($ billions) S
Sa + T
$20 billion increase
in taxes
$5 billion decrease
in saving Sa 40 20
I + G
(billions of dollars)
S + T, I + G I
Real GDP
( $billions )
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

21. Fiscal Policy over the Business Cycle
Expansionary fiscal policy
Increased G
Decreased T
or both
Moves Budget towards a deficit in recessionary times
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

22. Fiscal Policy over the Business Cycle (cont.)
Contractionary fiscal policy
Decreased G
Increased T
or both
Moves Budget towards a surplus in inflationary times
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

23. The Multiplier and Fiscal Policy
If the tax function is of the form
T = TLS + MPT(Y )
where MPT = marginal propensity to tax ,
Multiplier = [MPT + MPS (1 – MPT)]
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

24. Foreign Trade and Equilibrium GDP
Exports (X ) and imports (M ) are introduced into the model
Net exports (NX) = X – M
AE = C + I + G + NX
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

25. Slides prepared by Muni Perumal, University of Canberra, Australia
Exports (X)
Level of X depends on foreign countries’ income, not domestic income
Therefore X is an autonomous variable in the model
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

26. Slides prepared by Muni Perumal, University of Canberra, Australia
Imports (M)
Level of M is dependent on domestic income or GDP
Given autonomous exports, a rise in imports due to a rise in income results in a fall in NX
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

27. Equilibrium GDP with a rise in NX
(C + I + G + NX)2
(C + I + G)
(C + I + G + NX)0
510
490
470
450
Spending (billions of dollars) 45 o
Real GDP
($ billions)
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

28. Open-Economy Multiplier
The introduction of foreign trade reduces:
the expenditure multiplier
the slope of the AE curve
The open-economy multiplier = 1/[MPS + MPM],
if taxes are lump sum with
no marginal propensity to tax
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

29. The Complex Multiplier for an Open Economy
The multiplier that arises when all leakages—savings, taxes, and imports—are taken into account: k = [MPT + MPS (1 – MPT) + MPM]
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

30. Balanced-Budget Multiplier
The effect of an equal increase (or decrease) of both the level of government expenditure and taxation
Increases (decreases) the level of equilibrium GDP by exactly the amount of the increase (or decrease) in G and T
Thus, equal increases in G and T are expansionary
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia

31. Next Chapter: Aggregate Demand and Aggregate Supply
Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics 7/e by Jackson and McIver
Slides prepared by Muni Perumal, University of Canberra, Australia