Macroeconomics
We know that an increase in government spending causes an increase in aggregate demand and output ; therefore, we can deduce that a $10 million increase in government spending leads to an increase in real GDP by $25 million given an MPC = 0.6. Notable: ● WhenprovidedwiththeinitialGDPvaluebeforetheautonomouschangeinspendingandasked to calculate the new GDP, simply add the calculated impact on GDP to the original GDP. For instance, in the previous example, if the question specifed the initial GDPas$100million,the new GDP would be: $100 million + $25 million = $125 million. ● AhigherMPCleadstoalargermultiplier.Whenmoneyisspent,itbecomesincomeforanother entity, which is then spent, creating a chain reaction of spending. ● Always ask yourself whether the change in autonomous spending results in an increase or decrease in AD and GDP. For example, if the question specifes a decrease in investment or government spending, ensure you note that AD and GDP decrease . To refresh your understanding of how AD components impact output, refer back to Section Aofthischapter: Direct Components of AD. ● The extent of the shift of the AD curve following a change in a component of AD or real GDP. ● The impact of an increase or decrease in the spending level (i.e., government spending and investment) on the economy. ● Thelevelofspendingrequiredtocloseoutputgaps(whichwillbediscussedindetaillateron). Forinstance,ifweknowthatthemultiplieris3andthegovernmentaimstoincreaseoutputby $300million,wecancalculatethatonlyanadditional$100millioninspendingisneeded.Todo this,wecanrearrangethemultiplierformula:Multiplier=∆realGDP÷∆aggregateautonomous expenditure. Thus, 3 = $300 million ÷ ? In essence, the expenditure multiplier helps determine the following:
Checkpoint Quiz 1:
An economy has an MPS = 0.2 at a GDP level of $20 billion. How will a $2 billion decrease in investment affect GDP?
(Checkpoint answers are located at the end of the chapter under the review question answers.)
Tax Multiplier As part of fscal policies, governments change their spendinglevelandimposeorcuttaxestocorrect business cycle fluctuations. Now thatwe’velearnedtocalculatetheeffectofachangeinspendingon real GDP and the economy, it is time to calculate the effect of a change in taxes.
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