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The Multiplier Effect SFLS
- 2. Sooooooo… 1.) Full employment - about 5% unemployment 2.) Stability (Prices) 3.) Economic growth 4.) Balance of Payments Equilibrium - about 2% inflation - about 3% growth (7% in China) AD = C + I + G + (X – M) These are our Macroeconomic goals… This is our Macroeconomic equation… And the G in the equation is the government attempting to smooth out the business cycle with it’s policy… Expansionary Fiscal Policy Contractionary Fiscal Policy And there are two ways to enact either policy…
- 3. AD = C + I + G + (X – M) And there are two ways to enact either policy… Government spending Taxes And the two ways this is accomplished… Discretionary Fiscal Policy Automatic Stabilizers And there are the resources used to do this…
- 4. AD = C + I + G + (X – M) Federal Budget And there are the resources used to do this… Which comes from either… Taxes Borrowing Soooooooooooo……. The next question is how effective are these policies…
- 5. I work for the Government! Big G Man This Man represents the Government in our economy so we will call him… Let’s look at our country’s AD! Fiscal Policy Effectiveness Example
- 6. Price level GDP AD SRAS PE YN Y1 P1 LRAS Big G Man Oh No! the AD is below the long run equilibrium! Fiscal Policy Effectiveness Example
- 7. Price level GDP AD SRAS PE YN Y1 P1 LRAS I am sad for my country Big G Man Fiscal Policy Effectiveness Example
- 8. Price level GDP AD SRAS PE YN Y1 P1 LRASLet’s check the GDP spending numbers AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Fiscal Policy Effectiveness Example
- 9. Price level GDP AD SRAS PE YN Y1 P1 LRAS AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Our country has a $10 billion shortfall in AD Fiscal Policy Effectiveness Example
- 10. Price level GDP AD SRAS PE YN Y1 P1 LRAS AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Ok simply, the government can just spend $10 billion to fill this hole! Fiscal Policy Effectiveness Example
- 11. Fiscal Policy Effectiveness Example G Price level GDP AD SRAS PE YN Y1 P1 LRASOk simply, the government can just spend $10 billion to fill this hole! $10 billion Spending = AD $10 billion Big G Man
- 12. Fiscal Policy Effectiveness Example G Price level GDP AD SRAS PE YN Y1 P1 LRASOk simply, the government can just spend $10 billion to fill this hole! $10 billion Spending = AD $10 billion Big G Man
- 13. Fiscal Policy Effectiveness Example G Price level GDP AD SRAS PE YN Y1 P1 LRASOk simply, the government can just spend $10 billion to fill this hole! $10 billion Spending = AD $10 billion Big G Man This doesn’t work
- 14. Fiscal Policy Effectiveness Example G Price level GDP AD SRAS PE YN Y1 P1 LRASOk simply, the government can just spend $10 billion to fill this hole! $10 billion Spending = AD $10 billion Big G Man It doesn’t equal this, instead it equal…
- 15. G Price level GDP AD SRAS PE YN Y1 P1 LRASOk simply, the government can just spend $10 billion to fill this hole! $10 billion Spending = AD $50 billion AD1 Y2 P2 Big G Man If MPC is 0.8( ) Fiscal Policy Effectiveness Example This
- 16. G Price level GDP SRAS PE YN LRASOh no! the economy is overheating and now we have too much inflation! $10 billion Spending = AD $50 billion AD1 Y2 P2 = Inflation Fiscal Policy Effectiveness Example
- 17. G Price level GDP SRAS PE YN LRAS What did I do wrong? $10 billion Spending = AD $50 billion AD1 Y2 P2 = Inflation Fiscal Policy Effectiveness Example
- 18. AD = C + I + G + (X – M) Government spending Price level GDP AD SRAS PE LRAS YN Y1 P1 AD1 - Government spends more in the economy and makes jobs, people have more money and increase consumption. Fiscal Policy Effectiveness Example Must add a multiplier effect
- 19. AD = C + I + G + (X – M) Taxes Price level GDP AD SRAS PE LRAS YN Y1 P1 AD1 - Lower taxes means people have more money to use for consumption and also businesses have more money to increase investment spending. Fiscal Policy Effectiveness Example Must add a multiplier effect
- 20. - the number of times a rise in national income exceeds the rise in injections 注入 of demand that caused it The Multiplier effect the additional shifts in AD that result when fiscal policy increases income and thereby increases consumer spending (C) Reworded definition: 换句话说 Each $1 increase in G can generate more than a $1 increase in AD. Fiscal Policy Effectiveness
- 21. The Multiplier effect 1 1 – MPC = - the number of times a rise in national income exceeds the rise in injections 注入 of demand that caused it G spending Equation: or 1 MPS = Tax Equation: or Tax Equation: or The Multiplier Effect
- 22. 1.) The government buys airplanes from a domestic manufacturer. 2.) This is distributed to workers (wages) and owners ( profits or stock dividends). 3.) These people are also consumers and will spend a portion of the extra income. 4.) This extra consumption causes further increases in AD. Price level GDP AD Multiplier Effect Example
- 23. - the fraction of extra income that households consumes rather than save The Multiplier effect Marginal Propensity to Consume (MPC) Example: 1.) if MPC = 0.8 2.) if income rises by $100 3.) then C consumption rises $80 The size of the multiplier depends on MPC. Fiscal Policy Effectiveness
- 24. Marginal Propensity to Consume (MPC) The size of the multiplier depends on MPC. if MPC = 0.5 Multiplier = 2 if MPC = 0.75 Multiplier = 4 if MPC = 0.9 Multiplier = 10 Example sizes: Fiscal Policy Effectiveness
- 25. - the fraction of extra income that households saves rather than consumes Marginal Propensity to Consume (MPS) Marginal Propensity to Save Example: 1.) if MPS = 0.2 2.) if income rises by $100 2.) then C consumption rises $80 Fiscal Policy Effectiveness
- 26. I will spend more G money and make a new bridge! Big G Man Fiscal Policy Effectiveness Example
- 27. So I need to hire some workers to do it. Big G Man Fiscal Policy Effectiveness Example
- 28. Big G Man 给钱 做桥 G $10 billion Spending = AD $10 billion + … Workers Fiscal Policy Effectiveness Example
- 29. Workers Some of this money with will spend (MPC) = 0.8 We have earned some wages! Some of this money we will save (MPS) = 0.2 Fiscal Policy Effectiveness Example
- 30. Workers Let’s buy some new dresses! Fiscal Policy Effectiveness Example
- 31. Workers 给钱 Dress maker 做衣服 ($10 billion) $8 billion用钱 $2 billion存钱。 Fiscal Policy Effectiveness Example
- 32. Workers 给钱 Dress maker 做衣服 G $10 billion Spending + workers $8 billion Spending + … Fiscal Policy Effectiveness Example
- 33. Big G Man $10 billion Spending + … Workers + + Dress maker + $8 billion Spending $6.4 billion Spending + +… Fiscal Policy Effectiveness Example
- 34. Big G Man + … Workers + + Dress maker G $10 billion Spending + MPC = 0.8 of each round of income’s spending 1 1 – MPC = Fiscal Policy Effectiveness Example
- 35. Big G Man + … Workers + + Dress maker MPC = 0.8 of each round of income’s spending 1 1 – MPC = Multiplier = 5 Fiscal Policy Effectiveness Example
- 36. Big G Man + … Workers + + Dress maker G $10 billion Spending = AD $50 billion x Multiplier of 5 Fiscal Policy Effectiveness Example
- 37. A $10billion increase in G initially shifts AD to the right by $10billion. The increase in Y causes C to rise, which shifts AD further to the right. Y P AD1 P1 AD2 AD3 Y1 Y3Y2 $10 billion The Multiplier Effect
- 38. AD = C + I + G + (X – M)Government spending Y = C + I + G + NX identity Y = C + G I and NX do not change Y = MPC Y + G because C = MPC Y solved for Y1 1 – MPC Y = G The multiplier Fiscal Policy Effectiveness
- 39. Marginal Propensity to Consume (MPC) Price level GDP AD SRAS PE YN Y1 P1 LRAS Ok let’s try again! Big G Man
- 40. Price level GDP AD SRAS PE YN Y1 P1 LRASLet’s check the GDP spending numbers AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Fiscal Policy Effectiveness Example
- 41. Price level GDP AD SRAS PE YN Y1 P1 LRAS AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Our country has a $10 billion shortfall in AD Fiscal Policy Effectiveness Example
- 42. Price level GDP AD SRAS PE YN Y1 P1 LRAS AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man If I know the MPC in my country is 0.8 Fiscal Policy Effectiveness Example
- 43. Price level GDP AD SRAS PE YN Y1 P1 LRAS Then I use that in this equation 1 1 – MPC = = 1/1-0.8 = 1/0.2Big G Man Fiscal Policy Effectiveness Example
- 44. Price level GDP AD SRAS PE YN Y1 P1 LRAS 1 1 – MPC = = 1/1-0.8 = 1/0.2 = 5 Big G Man Now I know the multiplier! Fiscal Policy Effectiveness Example
- 45. Price level GDP AD SRAS PE YN Y1 P1 LRASI only have to spend $2 billion and that will equal $10 billion in total spending! AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Fiscal Policy Effectiveness Example
- 46. Big G man Price level GDP AD SRAS PE YN LRAS Hurry! Our Economy is saved! Fiscal Policy Effectiveness Example
- 47. AD = C + I + G + (X – M) Government spending Price level GDP AD SRAS PE LRAS YN Y1 P1 AD1 - Government spends more in the economy and makes jobs, people have more money and increase consumption. Fiscal Policy Effectiveness Example This has a multiplier…
- 48. AD = C + I + G + (X – M) Taxes Price level GDP AD SRAS PE LRAS YN Y1 P1 AD1 - Lower taxes means people have more money to use for consumption and also businesses have more money to increase investment spending. Fiscal Policy Effectiveness Example This has a different multiplier…
- 49. The Multiplier effect - the number of times a rise in national income exceeds the rise in injections 注入 of demand that caused it G spending Equation: or Tax Equation: or Tax Equation: or MPC 1 – MPC = MPC MPS = - MPC 1 – MPC = - MPC MPS = Fiscal Policy Effectiveness
- 50. AD = C + I + G + (X – M)Taxes Reduced taxes are not an injection of new money It “frees’” up current income into more disposable income Some is saved, some is spend, just like the Government Spending Multiplier but without the first injection of new money that is 100% spend. Tax Multiplier Effect
- 51. 1.) The government reduces income taxes for people 2.) People now have more disposable income (wages) and owners ( profits or stock dividends). 3.) These people are also consumers and will spend a portion of the extra income. 4.) This extra consumption causes further increases in AD. Price level AD However it is one less round then government spending it is a smaller multiplier Tax Multiplier Example
- 52. Price level GDP AD SRAS PE YN Y1 P1 LRAS AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Our country has a $10 billion shortfall in AD Tax Multiplier E ffect Example
- 53. What if instead of building a bridge and spending extra money like before, I just gave people tax cuts? Big G Man Tax Multiplier Effect Example
- 54. Big G Man WorkersBoss of Workers I will reduce all your taxes so you have more disposable income Tax Multiplier Effect Example
- 55. Big G Man WorkersBoss of Workers Hurry! I might even hire new workers! Tax Multiplier Effect Example
- 56. Big G Man WorkersBoss of Workers Hurry! Now we can buy more dresses! Tax Multiplier Effect Example
- 57. Price level GDP AD SRAS PE YN Y1 P1 LRAS AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man If I know the MPC in my country is 0.8 Tax Multiplier Effect Example
- 58. Price level GDP AD SRAS PE YN Y1 P1 LRAS AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Our country has a $10 billion shortfall in AD Tax Multiplier Effect Example
- 59. Price level GDP AD SRAS PE YN Y1 P1 LRAS Then I use that in this equation MPC 1 – MPC = = 0.8/1-0.8 = 0.8/0.2Big G Man Tax Multiplier Effect Example
- 60. Price level GDP AD SRAS PE YN Y1 P1 LRAS MPC 1 – MPC = = 0.8/1-0.8 = 0.8/0.2 = 4 Big G Man Now I know the tax multiplier! Tax Multiplier Effect Example
- 61. Price level GDP AD SRAS PE YN Y1 P1 LRASI have to cut taxes by 2.5 billion to get $10 billion in total spending! AD = Y1 = 90 billion current GDP AD =YN = 100 billion GDP Goal Big G Man Tax Multiplier Effect Example
- 62. Big G man Price level GDP AD SRAS PE YN LRAS Hurry! Our Economy is saved! Tax Multiplier Effect Example
- 63. The Multiplier effect 1 1 – MPC = - the number of times a rise in national income exceeds the rise in injections 注入 of demand that caused it G spending Equation: or 1 MPS = Tax Equation: or Tax Equation: or MPC 1 – MPC = MPC MPS = - MPC 1 – MPC = - MPC MPS = Fiscal Policy Effectiveness
- 64. So the Government can spend money and increase AD by a multiplier… Or the Government can decrease taxes an increase AD by a multiplier… So the Government spending has a bigger multiplier… However… Don’t forget the money isn’t free, it comes from the federal budget that has to be balanced, and if it’s in deficit this adds another problem. The Multiplier Effect
- 65. 3.1) Budget Deficit Problems Crowding out: - Government spending and borrowing that may fail to increase AD and hurts 排挤 private investment. - When the government has to borrow, it needs to borrow from the private sector. This could be private individuals, pension funds or investment trusts. It is argued that if the private sector buy government securities this will crowd out 排挤 private sector investment. - Typically this deals with the increase of interest rates due to attempting to sell more bonds to finance debt.
- 66. So a quick example of this… The Multiplier Effect
- 67. The economy is in recession. Shifting the AD curve rightward by $200billion would end the recession. A. If MPC = .8 and there is no crowding out, how much should the government increase G to end the recession? B. If there is crowding out, will the government need to increase G more or less than this amount? The Multiplier Effect Example
- 68. The economy is in recession. Shifting the AD curve rightward by $200billion would end the recession. A. If MPC = .8 and there is no crowding out, how much should the government increase G to end the recession? Multiplier = 1/(1 – .8) = 5 Answer: Increase G by $40billion to shift AD by 5 x $40billion = $200billion
- 69. The economy is in recession. Shifting the AD curve rightward by $200billion would end the recession. B. If there is crowding out, will the government need to increase G more or less than this amount? - Crowding out reduces the impact of G on AD. Answer: To offset this, the government should increase G by a larger amount, how much depends on the math involved.
- 70. Hope you understand! Thank you!