Section 4: Module 21 Mini Lecture AP Macroeconomics November 2016 Mr. Gammie

Urgent Economics The government needs to close a recessionary gap. The economy is currently operating at $50 billion below potential output (Yp) and unemployment is beginning to rise. Does the government need to inject $5 billion into the economy to close the gap?

NO

Spending Multiplier M = 1/(1-MPC)

Old news!

Urgent Economics If MPC = 0.9, how much does the government need to increase spending by to close the gap? 50= g*(1/1-0.9) 50- = g*(1/0.1) 50 = g*10 g = 5

Inflation Alert! The economy is currently producing at $800 billion above potential output (Yp). If MPC =0.75, what should the government do to fix the problem? -800 = g*(1/1-0.75) g = 200 Decrease gov’t spending by $200 B

Taxes and Transfers GDP = C + I + G + Xn What happens when your taxes are increased? What happens when you receive a transfer payment? Why is the effect on RGDP different than through government spending? GDP = C + I + G + Xn It affects Yd

Tax Multiplier = MPC/(1-MPC) Consumers will save some of every dollar earned (or given to them). Tax Multiplier = MPC/(1-MPC)

Spending Multiplier > Tax Multiplier ALWAYS

Time for a rather taxing question… The government has decided to lower taxes by $1000. MPC = 0.9 What is the effect on RGDP? Change = 1000*(0.9/0.1) = 9000 What change would have occurred if it was a 1000 increase in G? --- $10000.

Transferring tools… The government decreases transfer payment by $500. What is the effect if MPC = 0.8? = -500*(4) = $2000 If cut in G, = $2500

Tax Systems What is a progressive tax system? What effect does a progressive tax system have on disposable income as it changes?

Automatic Stabilizers Progressive tax systems Transfer payments – employment benefits “Non-discretionary fiscal policy”

Think about it… Country A has no unemployment insurance benefits and a tax system that uses on lump-sum taxes. Country B has generous unemployment benefits and a tax system in which residents must pay a percentage of their income, increasing as they earn more. Which country will experience greater variations in RGDP in response to demand shocks?

Discretionary Expansionary Contractionary

Key Concepts Fiscal policy has a multiplier effect. Government spending affects RGDP through the multiplier effect. If the multiplier is equal to M, one additional dollar of government spending creates $M of additional RGDP. A change in lump sum taxes or transfer payments also creates more RGDP through a similar, though smaller, multiplier effect. The spending multiplier is equal to 1/(1-MPC) The tax multiplier is equal to MPC/(1-MPC) The balanced budget multiplier is equal to 1. The multiplier effect is influenced by automatic stabilizers.