1. Multipliers & Fiscal Policy
MPC, MPS & Multiplier Analysis

2. MPC & MPS Importance Size of MPC/MPS determines how far AD shifts
Fiscal Policy has a multiple affect on AD
If G↑ 1 billion => Real GDP ↑ by more than 1 billion!
LRAS1
Price
Level
Real
GDP
SRAS1
AD1

3. Gov’t Spending/Investment Multiplier
Multiplier = ∆GDP / ∆ Gov’t Spending
GDP increases more than Gov’t spending rises
2-ways to calculate multiplier: (you need to know MPC or MPS)
1/(1-MPC) or /MPS
Example: If MPC = /(1-.80) = 5 or 1/.20 = 5

4. Multiplier & GDP
Gov’t Spending & investment have “multiple” affect on GDP
Government raises spending $100
PRODUCT
Market
If MPC = .80
FIRMS
HOUSEHOLDS
Change in GDP:
Round 1 $100.0
Round $80.0
Round $64.0
Round $51.2
Etc…..
FACTOR
Market
Multiplier = 5 i.e. 1/MPS => 1/.20 = 5
So a $100 ↑ => causes Real GDP ↑ $500

5. The Tax Multiplier Multiplier = ∆GDP / ∆ Taxes
Is always smaller by 1 than spending/investment multiplier
spending multiplier = 5 => then tax multiplier = 4
TM = -MPC/MPS or -MPC x (spending multiplier)
Example: $200 tax cut MPC = .80
Example: MPC = /(1-.80) = 5
TM = * 5 = -4

6. Balanced Budget Multiplier
Always equal to 1 (regardless of size of MPC)
Example: Government ↑ Taxes & ↑ Spending by 1 billion
Example: Spending Multiplier = 10
Tax Multiplier = 9
Always a difference of 1
G ↑ 1 billion = > Real GDP ↑ 10 billion
Tax ↑ 1 billion => Real GDP ↓ 9 billion
Net Effect: Real GDP ↑ 1 billion

7. Multipliers & Fiscal Policy Worksheet
LRAS1
Price
Level
Real
GDP
SRAS1
AD1