Download The Multipliers

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Systematic ups and downs in GDP
Expansions, recessions
Peaks, Troughs
Overall the trend is growth of Real GDP
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Carried out by the National Government
Started with the ideas of John Maynard Keynes
Help the US administration with his ideas of how to stop
the Great Depression from getting worse
He believed in fixing problems now, by increasing and
decreasing spending (GDP)
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There are two tools of fiscal Policy
o Taxes and Government Spending
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Government spending is the most direct form
Economy in recession and need a boost?
o Lower taxes
o Raise government spending
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Economy overheated and need to slow down?
o Raise taxes (Mondale)
o Lower government spending
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The problem with this policy is it often leads to unseen or
increased spending
Can lead to a “Budget Deficit”
o Spending more than you make (have to borrow)
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Contractionary fiscal policy can lead to “Budget Surplus”
o More income than expenditures (can pay debt)
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Whenever you spend money that amount becomes
income for someone else
Example: You buy a new TV from Best Buy, they take a
portion of this money and invest in new computer
terminals….
So there are only two things we (C,G,I,Xn) can do with
our Money
o Spend
o Save
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Using aggregate data from income, GDP, savings
The propensity to spend additional income is known as
Marginal Propensity to Consume (MPC)
The propensity to save additional income is known as
Marginal Propensity to Save (MPS)
These are given in percentages
Since we can either save or consume, MPS + MPC = 1
o MPC and MPS are percentages
o So if you spend 90% of your income then MPC is .9
o And your MPS has to be .1 (MPS + MPC = 1)
o Can you have a negative savings percentage?
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Joe makes $10,000 a month
He gets a raise of $900 from his company per month
After this raise his savings account increases by $450
per month, while his spending increases by $450
What is Joe’s MPC and MPS?
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MPC and MPS help us get two types of multipliers
Both are related to Fiscal Policy
Expenditure Multiplier: Related to changes is spending
Tax Multiplier: Related to changes in taxes
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Shows how much a change in spending (C, G, Ig, Xn)
will affect GDP
Me = 1/MPS
With a consumer MPC of .9, an increase in consumer
spending of $10m could change GDP by how much?
o Me = 1/.1 (or 10)
o So 10 multiplied by $10m
o Could change GDP by $100m
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The MPC of the average American is estimated to be .75
(75%)
If the government wishes to boost GDP and decides to
do so by spending on public works projects what would
the multiplier (Me) be?
If they wanted to boost spending by $400m then how
much would they need to spend on these projects?
o 1/.25 = 4
Me= 4
o Desired boost = $400
o Increase spending by $100
$400/4= $100
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A Change in taxes (T) will change disposable income
(DI) and thus change consumption
An increase in taxes would potentially lower
consumption while a decrease could increase
consumption
This one tells us how much GDP will change as a result
of a change in taxes
Mt = MPC/MPS
So change in taxes (can be negative) and their effect on
GDP is shown as:
o T x Mt = Change in GDP
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Consumers MPC is .9 (90%)
So MPS is .1
Mt = .9(MPC)/.1(MPS)
o Mt = 9
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So the government increases taxes by $100m (-T)
Change in GDP = -$100m x Mt (9)
o Potential decrease in GDP of $900m
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Example #1: Increase taxes and decrease government
spending
Budget Surplus
Example #2: Increase government spending while taxes
stay the same
Budget Deficit
Example #3: Decrease taxes and decrease government
spending or Increase in both
???????
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Mb = Me – Mt = 1
Why?
Remember MPC and MPS (not all income is spent)
So….
Equal increases in government spending and taxes will
increase equilibrium GDP by an amount equal to the
increase in government spending
Decreases will have the opposite effect
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Consider the following data:
o A countries MPC is .9 so MPS is .1
o Therefore the Me is 10 (1/MPS)
o And the Mt is 9 (MPC/MPS)
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Government wants to increase GDP by $10m without
causing inflation….so…..
The government decides to increase spending by $10m
and increase taxes by $10m
So Me of Government spending is 10 x 10 or $100m
increase in G after the multiplier
Mt of increase in taxes is 9 x -$10m or a potential loss of
$90m in C spending after tax increase
So potentially GDP can increase by $10m without creating
a budget deficit or inflationary pressure
 Additional
income may be spent on imports
 In recent decades, new income may be used on
old debt
 Inflation can affect the effect (affect/effect?)
 Changes in the “Animal Spirits”
 Remember these are not absolutes, but we
need somewhere to start