macro 3.2, 3.8--3.9

multiplier effect

a magnified effect on the macroeconomy that results from an initial change in spending

MPC (marginal propensity to consume

the increase in consumer spending when disposable income rises by one dollar

• MPC = ΔConsumer spending / ΔDisposable income

• 0 = consumers spend no additional dollar

• 1 = MPC spend all additional dollar

MPS

marginal propensity to save; the increase in household savings when disposable income rises sby $1

• MPC + MPS = 1

increase in investment spending

direct effect is increase income and value of aggregate output by the same amount

• businesses that support home improvement and interior design benefits during housing booms because increase in aggregate output leads to increase In disposable income that flows to households in the form of profits and wages

increase in household disposable income

increase in consumer spending → induces firms to increase output again → another rise of disposable income → increase in consumer spending → repeat

expenditure multiplier

1 / (1 - MPC) or 1 / MPS

• the ratio of the total change in real GDP caused by autonomous change in aggregate spending to the size of that autonomous change; indicates the total rise in real GDP that results from each $1 of an initial rise in spending

• if MPC is high, so it expenditure multiplier (less disposable income leaks out)

• lower MPC = less spending and multiplier effect is smaller

• (total change in real GDP) = 1/(1 - MPC) x (autonomous change in aggregate spending)

tax multiplier

equal to -MPC(1 - MPC); the factor by which a change in tax collections changes real GDP

• increase real GDP/inflationary: increase spending and decreasing taxes

• decrease real GDP/contractionary: decrease spending and increasing taxes

• effect of taxes on real GDP has inverse relationship

• tax multiplier is negative because spending decrease when taxes increase, and spending increase when taxes decrease

stabilization policy

the use of government policy to reduce the severity of recessions and rein in excessively strong expansions

• under active stabilization policy, the US economy returned to potential output in 1996 from recessionary gap

• not always guaranteed to work

• government’s use of fiscal or monetary policy to prevent recessions and inflations

fiscal policy

the use of government purchases of goods and services, gov transfers, or tax policy to stabilize economy, done by government/congress

• works to achieve goals like full employment and stable prices through changes in AD

• increasing spending and decreasing taxes

• gov purchases of goods and services directly affect bc it is a commpoennt of AD (increase in gov purchases shift AD right)

• changesi n tax rates/gov transfers influence economy indirectly because it affects disposable income

  • lower taxes and higher gov transfers = increases consumers disposable income (AD right)

  • higher taxes and lowerr gov transfers = decreases disposable income (AD left)

expansionary fiscal policy

increases aggregate demand to close a recessionary gap; involves the gov increasing spending and transfer payments or decreasing taxes

• increases AD, shift right)

contractionary fiscal policy

reduces aggregate demand to close an inflationary gap; involves the government decreasing spending or transfer payments, or increasing taxes

• AD must decrease to make euilibirum output equal the potential output and reduce price level

negative supply shock

• short run: leads to lower aggregate output and higher aggregate price level

• can eb responded to by increasing aggregate demand to its original level

• supply shocks: two things happening simultaneously

time lags

caution needed when using fiscal policy

• gov has to realize that recessionary gap exists; takes time to collect and analyze

• gov has to develop a spending plan and pass legislation

• takes the time to actually spend the money

• an attempt of increase spending to fight a recessionary gap may take very long to the point where the economy will probably already recover on its own

discretionary fiscal policy

result of deliberate actions by policy makers rather than rules 

• passing legislation

• even when the government does not engage in discretionary fiscal policy in response to an output gap, changes in  aggreagte demand move the economy back toward full employment

nondiscretionary policies

require no legislation or other action; happens automatically based on already established gov rules

• may be automatically work to stabilize economy by increasing aggregate demand during recessions and reducing aggregate demand during inflation

automatic stabilizers

government spending a ndtaxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands

• ex: increase in gov tax revenue when real GDP goes up —> consequence of current tax laws already written; cause omost courses of gov revenue to increase automaticlaly