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$10B + 9B = 19B
Now when people who receive the $9B, they are going
to spend 90%, or $8.1B and save 10%, or $900 Million.
SUBTLETY ALERT!!
Notice in the VERY FIRST round of spending by the Government
that NOTHING is SAVED. The economy has the benefit of the
FULL impact of the $10Billion in new spending. In subsequent
rounds of spending people are saving a portion of the money
they receive, therefore REDUCING the impact on the economy.
When we do the TAX CUT MULTIPLIER next, this distinction
will be important. It forms the foundation of why Keynes
suggested that in times of severe economic crisis it should be
the role of Government to be active in the economy.
KEYNESIAN MULTIPLIER
EFFECTS
Instead of Government
changing its spending, they
could change TAXES instead.
KEYNESIAN MULTIPLIER
EFFECTS
The people who receive the $8.1Billion are going to SPEND 90%,
or $7.290 Billion and SAVE 10%, or $810 Million
Once again, it does not stop here. Each time the money is spent
it keeps reducing by the 90% and 10% ratio UNTIL it gets to
ZERO and GDP is some much larger number.
KEYNESIAN MULTIPLIER
EFFECTS
Example:
We know the MPC is 90% and the MPS is 10%.
We can plug the appropriate number into the Tax Cut
Multiplier and come up with a useful number.
Tax Cut Multiplier
This means that ANY dollar the Govt spends in the economy is
going to multiply on itself 4 TIMES
This means that ANY dollar received in Tax Cuts in the economy is
going to multiply on itself 3 TIMES
2. What is the value of the government spending multiplier if the MPC is 0.67? ____________________________
i. Calculate the minimum increase in govt. spending that could bring about full employment.
k = 1/1-0.8 = 1/ 0.2 = 5
Required Change in G = desired Change in AD/k = 500b/5 = Increase in govt. spending $100b
ii. Assume that instead of increasing govt. spending, the government decides to reduce personal income taxes. Will the
reduction in personal income taxes required to achieve full employment be larger than or smaller than the govt. spending
change you calculated in part i. Explain why.
T = -MPC/MPS = -0.8/0.2 = -4
Needed change in tax = desired change in AD/-t (desired tax multiplier) =500b/-4 = -125
Tax must fall by $125b