Chapter 18 – Fiscal Policy & Multipliers

Flashcards cover definitions, formulae, conceptual relationships, numerical applications, and true-false statements relating to the government-purchases multiplier, tax multiplier, and overall fiscal multiplier effects discussed in Chapter 18.

Why can a $1 increase in government purchases raise total income and spending by more than $1?

Because the government-purchases multiplier causes the initial $1 of spending to raise aggregate demand, which induces further rounds of consumption and income.

How is the government-purchases multiplier formally defined?

Government-purchases multiplier = (Δ equilibrium real GDP) ÷ (Δ government purchases).

How is the tax multiplier formally defined?

Tax multiplier = (Δ equilibrium real GDP) ÷ (Δ taxes), usually negative because higher taxes reduce GDP.

What happens to the size of the multiplier effect when the tax rate rises?

It becomes smaller; a higher tax rate leaks more income out of the spending stream.

In the Caldecott Tunnel project, what did officials mean by a “ripple effect” on employment?

Job creation would spread beyond construction to other industries as tunnel workers spend their earnings throughout the economy.

A recessionary gap of $600 billion exists and the government-purchases multiplier is 5. By how much must government spending rise to close the gap?

By $120 billion ($600 billion ÷ 5).

If the tax multiplier is –4 and the recessionary gap is $600 billion, by how much must taxes be cut to close the gap?

By $150 billion ($600 billion ÷ 4).

If government purchases fall $300 billion (or taxes rise $300 billion) and the multipliers are greater than 1, real GDP will change by how much?

By more than $300 billion in the same direction, so GDP falls by more than $300 billion.

If the short-run aggregate-supply curve were horizontal, how would that affect the size of fiscal multipliers?

Multipliers would be larger because changes in demand translate fully into output with no price-level increase.

Why do one-time tax rebates boost consumption less than permanent tax cuts?

They raise current income but not permanent income, so households save more of the temporary windfall.

According to the multiplier effect, an initial cut in government purchases reduces real GDP by how much relative to the initial cut?

By more than the initial reduction, because each lost dollar of spending triggers additional decreases in consumption.

After an increase in government spending shifts AD right, why does actual GDP rise by less than the simple multiplier predicts when prices are flexible?

Because part of the demand increase shows up as a higher price level, dampening the output response.

Is the multiplier effect relevant only for increases in government purchases?

No. It applies to both increases and decreases in government spending as well as to tax changes.

If the tax multiplier is 1.9 and taxes fall $68 million, by how much does aggregate demand rise (ceteris paribus)?

By about $129.2 million (1.9 × $68 million).

Does a higher tax rate make the multiplier effect larger or smaller?

Smaller; more of every additional dollar earned is siphoned off as taxes, reducing induced consumption.

True or False: The actual change in real GDP from fiscal policy is usually less than the simple multiplier implies.

True; upward-sloping SRAS, price-level changes, and crowding-out all dampen the effect.