In 2016, economists forecast the U.S. MPS will be 0.15 and the MPM will be 0.10.

Question

In 2016, economists forecast the U.S. MPS will be 0.15 and the MPM will be 0.10.Estimate the maximum overall total effect on national income of the following two changes in fiscal policy:

a) If a decrease in govt spending of $100 billion and a decrease in taxes of 50 billion.

b) If fiscal policy is unchanged (ignore part a above) but GPDI from business increases as below, what will be the maximum
impact on national income?

An increase in planned business investment spending of $60 billion without any change in fiscal policy.

c) What are some reasons why the maximum multiplier effect might not happen in the U S?

Explanation / Answer

Spending multiplier = 1 / (MPS + MPM) = 1 / (0.15 + 0.1) = 1 / 0.25 = 4

Tax multiplier = - (1 - MPS) / MPS = - (1 - 0.15) / 0.15 = - 0.85 / 0.15 = - 5.67

(a) When government spending falls by $100 billion, national income (NI) falls by $100 billion x 4 = $400 billion.

At the same time, as tax falls by $50 billion, NI rises by $50 billion x 5.67 = $283.5 billion

Net effect is a fall in NI equal to $(400 - 283.5) billion = %116.5 billion

(b) As business spending increases by $60 billion, NI increases by $60 billion x 4 = $240 billion.

(c) Maximum multiplier effect does not happen due to leakages from the multiple rounds of changes in NI as well as time lags, which weaken the propagation effect of the multiplier.

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.