the spending multiplier

Multiplier effect - the magnified impact of a change on aggregate demand; price level stays constant, change in spending at one price value.

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Marginal Propensity to Consume - the effect on domestic consumption of a change in income -

MPC = Change in consumption on domestic items / change in income

Marginal Propensity to Withdraw - the effect on withdrawals 0 savings, imports, and taxes - of a change in income

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MPW = change in total withdrawals / change in income

1 = MPC + MPW

MULTIPLIER EFFECT

Is the magnified impact of any spending change on aggregate demand. It assumes that the price levels stays the same.

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The multiplier effect is the change in spending at one price level multiplied by a certain value to give the resulting change in AD

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Consumption Function

Calculates the amount of total consumption in an economy. It is made up of autonomous consumption that is not influenced by current income and induced consumption that is influenced by the economy's disposable income level

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Consumption

Disposable Income

C = Yd

C = Autonomous consumption + MPC / Yd

Marginal Propensity to Consume

Measures the rate at which consumption is changing when disposable income is changing. In a geometric fashion the MPC is the slope of the consumption function

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Is the effect on domestic consumption of a change in income:-

change in incomeMPC = change in consumption on domestic items

The Spending MultiplierDecember-09-08

8:19 AM

Unit 3 - Fiscal Policy

Marginal Propensity to Withdraw (SAVE)

Withdrawals: savings, taxes, imports-

Is the effect of a change in income on withdrawals. It is the change in total withdrawals as a proportion of the change in income.

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Marginal propensity to save : measures the rate at which savings is changing when disposable income is changing

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Change in IncomeMPW = Change in total withdrawals

Consumption

C = 50 + .85YD

This equation means that out of every extra dollar in disposable income 85 cents is spent on consumption. Therefore the MPC = .85, the MPS = .15.

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Disposable Income, Consumption and Savings

YD C MPC S MPS

100 135 -35

200 220 .85 -20 .15

300 305 .85 -5 .15

400 390 .85 10 .15

500 475 .85 25 .15

As income levels increase people tend to consume by the same percentage-

That is the rich in society spend at the same rate as the poor -

The Spending Multiplier

Initial change x spending multiplieri.Total change in Output =a)

Initial change in spendingTotal change in output (shift in the AD curve)i.

Spending Multiplier =b)

1i.MPW

Spending Multiplier =c)

Is the value by which the initial spending change is multiplied to give the total change in the output. (The shift in the AD curve)

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Average propensity to Consume is the ratio between a person's total and disposable income and his/her total consumption

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Average Propensity to Save is the ratio between a person's total disposable income and his/her total savings

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Marginal Propensity

Marginal Propensity to Consume is the ratio between a person's change in disposable income and his consumption

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Marginal Propensity to Save is the ratio between a person's change in disposable income and his change in savings

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APC = C / Yd APS = S / Yd

Benefits of Fiscal Policy


Regional focus - some part of the country may be more effected than others by the business cycle1.Impact on spending - when the first spending is assured by the government - multiplier effect 2.

Drawbacks of Fiscal Policy

Recognition Lag - is the amount of time it takes policy makers to realize that a policy is neededa)Decision Lag - is the period that passes while an appropriate response is formulated and implemented

b)

Impact Lag - is the time that elapses between implementing the policy and having its effect on the economy

c)

Policy Delays:1.

Discretionary Fiscal Policy - highly visible elements of government activity.a)Political Visibility:2.

Is the total amount owed by the federal government as a result of its past borrowing a)Public Debt Charges - is the amounts paid out each year by the federal government to cover the interest charges on its public debt.

b)

Public Debt:3.

11.2 Practise Questions

1 milliona)0.33b)1/MPWc)

-1.

SM = 1.67, shift to left by 6667a)-(MPC x change in T) x 1 / mpwSM = 1.25, shift to right by 6250b)3750c)-66666.666667d)

-2.


the spending multiplier

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