AP Economics

Mr. Bernstein

Module 21: Fiscal Policy and the Multiplier

February 11, 2015

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AP EconomicsMr. Bernstein

Fiscal Policy and the Multiplier• Objectives - Understand each of the following:• Why Fiscal Policy Has a Multiplier Effect• How the Multiplier Effect is influenced by Automatic

Stabilizers

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AP EconomicsMr. Bernstein

Multiplier Effect of an Increase in Government Purchases of Goods and Services• MPC = .90; so spending multiplier M = 1 / (1-.9) = 10• Increase G by $50b leads to $50b x 10 = $500b

increase in AD• Decrease in G works similarly• Recent example: The Sequester

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AP EconomicsMr. Bernstein

Multiplier Effect of Changes in Government Transfers and Taxes• MPC = .90; so spending multiplier = 1 / (1-.9) = 10• Reducing Income Taxes by $10b leads to $10b x .9

= $9b increase in new spending, which then multiplies into $9b x 10 or $90b increase in AD

• Tax Multiplier Tm = MPC*M = MPC/(1-MPC)• Increase in Transfers works similarly• Recent example: Reduction in SNAP

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AP EconomicsMr. Bernstein

Automatic Stabilizers• Government spending and taxation rules that cause

fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands, without requiring any deliberate action by policy makers

• Progressive tax rates• AKA “Non-discretionary” fiscal policy• Example: Increase G4 AD increases4 Yd increases4

then taxes increase4 Yd increases slow