Macroeconomics
The tax multiplier calculates theeffectofanincreaseordecrease in taxesonrealGDP .SincehighertaxesreduceGDPbydecreasing consumption,andlowertaxesraiseGDPbyincreasingconsumption, the taxmultiplierisalwaysnegative .Itisalsoconsistently lessin magnitudethantheexpendituremultiplier ,meaningthattheeffect ofachangeinspendingislargerthantheeffectofthesamechange intaxesonrealGDPandtheeconomy.Thisisduetothefactthatthe impact of taxes is not direct. While government spending and investment are direct components of AD, taxes are indirect components that affect consumption or investment, which in turn, affect real GDP.
The tax multiplier is calculated as follows: = − − 1− For example,ifMPSinaneconomyis0.4,wecandeducethatMPC=1−0.4=0.6.Therefore,thetax multiplier is −0.6/0.4 = −1.5. NowassumethataneconomyhasarealGDPof$5billionandanMPCof0.3.Howwoulda$30million increase in taxes affect this real GDP? Tax multiplier = −0.3/0.7 ≈ −0.4. Final impact on GDP = tax multiplier × tax change = −0.4 × $30 million = −$12 million. Tax multiplier =
Therefore, real GDP will decrease by $12 million.
New real GDP level = $5 billion − $12 million = $4.988billion. Definition of Crowding-Out Efect
When the government increases its purchases or lowers taxes as part of its fscal policy,itincreases moneyinjectionsintotheeconomy.Thisadditionalmoneystimulatesconsumerspendingandbusiness investments. As consumers spend more, businesses produce more,leadingtoincreasedincomesand even more consumer spending. This chain reaction continues, amplifying the initial impact. The multiplier effect, as we’ve seen, measures how much an initial change in spending or income multiplies throughout the economy . Forexample,ifthegovernmentincreasesspendingby$20billion
and the multiplier is 4, the overall increase in demand forgoodsandservicescouldbe$80billion (4 times the initial spending increase). However, fscal policy can also have unintended consequences . When the government increases spending,itoftenneedstoborrowmoneytofnance it. This increases the demand for loans, which, in
88
© 2024 ACHIEVE ULTIMATE CREDIT-BY-EXAM GUIDE|MACROECONOMICS
Made with FlippingBook - Online Brochure Maker