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Module 21 Fiscal Policy and the Multiplier KRUGMAN'S MACROECONOMICS for AP* Margaret Ray and David Anderson What you will learn in this Module: • Why fiscal policy has a multiplier effect • How the multiplier effect is influenced by automatic stabilizers Multiplier Effects of an Increase in Government Purchases of Goods and Services • Initial increase in spending • Indirect effect of increased spending • Remember the multiplier Multiplier Effects of Changes in Government Transfers and Taxes • Taxes and Transfers compared to Government Spending • Transfers • Tax cuts • Taxes • Lump-sum taxes Multiplier Effects of Changes in Government Transfers and Taxes Suppose the government decides to lower income taxes by a lump-sum $1000. The MPC = .90. When Americans get $1000 back into their pockets, they will save $100 (10%) and spend $900 (90%). $900 of new spending will now multiply by a factor of 10 because M=1/.90 = 10. So $1000 tax cut will eventually multiply into $9000 of additional real GDP. How Taxes Affect the Multiplier • The reliance of taxes on real GDP • Effect on the multiplier • Automatic stabilizers • Discretionary Fiscal Policy What will YOU do with your stimulus check? Table 21.1 Hypothetical Effects of a Fiscal Policy with a Multiplier of 2 Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers
