# SPENDING MULTIPLIER (FISCAL POLICY. MULTIPLIER EFFECT, MPC& MPS  MPC : Marginal Propensity to Consume - The portion (%) of additional income that is.

## Presentation on theme: "SPENDING MULTIPLIER (FISCAL POLICY. MULTIPLIER EFFECT, MPC& MPS  MPC : Marginal Propensity to Consume - The portion (%) of additional income that is."— Presentation transcript:

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. - Since you can only “consume” or “spend”…. MPC + MPS = 1

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

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.

Multiplier = 1/MPS MPCMULTIPLIER MPC =.9 MPC =.8 MPC =.5 MPC = 0 - 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!!!

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…

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?

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)

FISCAL POLICY - PROBLEMS 1. Deficit Spending – if the gov’t increases spending without increasing taxes, they will increase the annual deficit and the national debt. 2. Time Lags – Congress takes time to write, debate, pass, and implement legislation 3. 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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