Chapter 9 The Government and Fiscal Policy More on the Multiplier Appendix B and Added Material

 FIGURE 9B.1 The Tax Function CHAPTER 9 APPENDIX B The Case in Which Tax Revenues Depend on Income This graph shows net taxes as a function of aggregate income.

The Government Spending and Tax Multipliers Algebraically: t is the tax rate, the percent of each additional dollar of income paid as taxes. Solving for Y: We know Y = C + I + G. Through substitution we get:

This means that a $1 increase in G or I (holding a and T 0 constant) will increase the equilibrium level of Y by Holding a, I, and G constant, a fixed or lump-sum tax cut (a cut in T 0 ) will increase the equilibrium level of income by Spending Multiplier = Lump Sum Tax Multiplier =

Comparison of simple multiplier to more realistic multiplier. Suppose MPC = 0.8 and t =.25. Simple multiplier Multiplier with t=.25:

ADD IMPORTS Simple Multiplier =

American Reinvestment and Recovery Act (ARRA) –An $800 billion fiscal stimulus –One-third was tax cuts –One-third was greater government purchases –One-third was increased transfer payments 8

Range of Estimates for Multipliers in the ARRA 9