Download The Magic of the Multiplier

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The Magic of the Multiplier
Demonstrate understanding of concepts:
Calculate aggregate changes in GDP based
from tax and spending multipliers
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ECONO-ISLAND
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MULTIPLIER EFFECT
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THE MULTIPLIER ΔY=M×ΔS
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Looking to see how a change in spending will impact aggregate
output
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Assuming no taxation, foreign market interaction, or simultaneous
spending changes
Example:
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US gov’t decides to spend $100B on new high-speed rail system
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1−MPC
× $100B = total change in real GDP
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Example:
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MPS = .60 ΔGDPReal = ?
• The Multiplier formally
represents the ratio of
total change in GDP to the
initial change in spending,
thus:
M = ΔY
ΔS
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APC & APS vs. MPC & MPS
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You already know about MPC & MPS…
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APC & APS: average propensities to consume & save
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Ratios of total spending/consumption or saving to disposable
income
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APC = C
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APS = S
DI
DI
*These #s can be greater than 1!
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TAX MULTIPLIER
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Taxation makes the multiplier work in reverse…there’s
money leaving the circular flow that households will no
longer have the opportunity to spend
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Disposable income is decreasing, ultimately
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Aggregate output decreases when taxes are increased, and
vice-versa
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Formula: TM =
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*Note: If there is a tax cut, then the multiplier will be
positive…more money in the economy (greater DI)
−MPC
MPS
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TAX MULTIPLIER and GDP
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All we do is calculate how our consumption will changed
based on the new tax level (please pay careful attention to
whether the tax rate is increasing or decreasing)
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Example: Let's say that we are experiencing a recession and
the government decreases taxes by $25 billion. Let's also
assume that the MPC equals .75. By how much will GDP
increase?
Solution: Because the MPC equals .75, the regular (spending)
multiplier equals 4, and the tax multiplier equals -3.
The spending multiplier = 1 / (1 minus .75) = 1 / .25 = 4. The tax
multiplier equals 4 minus 1 with a negative sign: -(4 - 1) = -3.
To get the increase in GDP, we multiply the multiplier by the
decrease in taxes:
Change in GDP = -3 x -$25 billion = +$75 billion.
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THE KING’S MULTIPLIER TEST
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“The King took the treatise and had it printed for every
islander. He then ordered the old professor to make up a
series of questions to see if the subjects understood the
multiplier.”
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Get with a partner, take out one cell phone per group, and
get ready to stake your place on Econoland Island!
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SAMPLE PROBLEMS
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Choose 1 to complete:
1.
Assume US citizens spend 90¢ for every $ they earn. Further,
assume that the real interest rate (r%) decreases, causing a
$50 B increase in gross private investment. Calculate the
effect of this $50 B increase on GDP.
2.
Assume Germany raises taxes by €200 B. Further, assume
Germans save 25% of the change in their disposable
income. Calculate the effect of this €200 tax increase on GDP.
3.
Assume the Japanese spend 4/5 of their disposable income.
Further, assume the Japanese gov’t increases spending by
¥50 T and, in order to maintain a balanced budget,
simultaneously increases taxes ¥50 T. Calculate the two
changes effects on GDP.
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ANSWERS #1
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ANSWERS #2
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ANSWERS #3