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SPENDING MULTIPLIER

SPENDING MULTIPLIER. (FISCAL POLICY. MULTIPLIER EFFECT, MPC& MPS. MPC : Marginal Propensity to Consume - The portion (%) of additional income that is spent. How much would you spend? MPS: Marginal Propensity to Save The portion (%) of additional income that is saved.

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SPENDING MULTIPLIER

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  1. SPENDING MULTIPLIER (FISCAL POLICY

  2. MULTIPLIER EFFECT, MPC& MPS • MPC : Marginal Propensity to Consume - The portion (%) of additional income that is spent. How much would you spend? • MPS: Marginal Propensity to Save • The portion (%) of additional income that is saved. • Since you can only “consume” or “spend”…. MPC + MPS = 1

  3. MULTIPLIER EFFECT • $100 million dollars on a new school… - electricians (c or s?) - new work truck (c or s?) - movies (c or s?) - cell phone (c or s?) • Money that gets dumped into store or businesses gets multiplied, therefore… MULTIPLIER = 1/MPS

  4. MULTIPLIER EFFECT • $100 Billion dollars MPC = 80% = .8 MPS = 20% = .2 Multiplier = 1/MPS 1/.2 = 1/(2/10) = 1/(1/5) = 5 Therefore, the new amount is $500 Billion When money is spent in the economy, that money is multiplied.

  5. Multiplier = 1/MPS • Multiply the numerator and the reciprocal of the denominator. • The more we spend (consume) the more multiplied • If people are spending more, then government doesn’t have to spend as much. • An increase in gov’t spending DOES NOT increase the money supply!!!

  6. Spending Multiplier Practice • Look at “Unit 3” handout • Decreasing Taxes – changes in gov’t spending have a greater effect on AD than changes in taxes because part of a tax is saved. • People only spend half a tax cut, so only half gets multiplied. • Practice…

  7. GOVERNMENT SPENDING • Assume the MPC is .5. How much should the gov’t increase spending to close the gap? • Assume the MPC is .8. How much should the gov’t increase spending to close the gap?

  8. TAXES • If the MPC is .5 how should gov’t change taxes to close the recessionary gap? • If the MPC is .8 how should gov’t change taxes to close the recessionary gap? ($40B to close the gap)

  9. FISCAL POLICY - PROBLEMS • Deficit Spending – if the gov’t increases spending without increasing taxes, they will increase the annual deficit and the national debt. • Time Lags – Congress takes time to write, debate, pass, and implement legislation • Crowding Out – Gov’t spending might cause unintended effects that weaken the impact of the policy. (Ex. Deficit spending increase AD therefore, interest rates increase and business investments decrease.

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