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

2. 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?

3. NO

4. Spending Multiplier
M = 1/(1-MPC)

5. Old news!

6. 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

7. 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

8. 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

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

10. Spending Multiplier > Tax Multiplier
ALWAYS

11. 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.

12. 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

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

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

15. 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?

16. Discretionary
Expansionary Contractionary

17. 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.