Deck 12: Fiscal Policy

Question 1

( a ) The multiplier process depicted in Table 12.1 is based on an MPC of 0.75. Recompute the first five cycles using an MPC of 0.80.
( b ) How much more consumption occurs in the first five cycles?
( c ) What is the value of the multiplier in this case?

Answer 1

(a) If the MPC is 0.8 the following table shows how through successive spending cycles the multiplier process leads to expansion of aggregate real income up to the first five cycles. The computations are shown in the table as follows:
(b) The table below shows the consumption amounts that occur at each of the first five spending cycles for MPC = 0.75 and MPC = 0.80. The last column of the table shows how much more consumption occurs when MPC = 0.80 at each cycle.
To find the total amount by which consumption is higher when MPC = 80 percent, we simply add the differences at each cycle. Thus, as can be seen from the table, consumption is higher when MPC = 0.80 by the following amount:
(c) The value of the multiplier is:

Question 2

What do people do with that fraction of their income they save?

Answer 2

People either hold the fraction of income they save in the form of cash or alternatively deposit it to a bank or other financial institution. If the money is held or "put under the mattress", it does not contribute to the expansion of the economy. Moreover, inflation erodes the value of the money holding over time. However, if the money is deposited to a bank, it can be used to make loans to other people of businesses, and this leads to expansion of the economy.

Question 3

Suppose the government increases education spending by $20 billion. How much additional consumption will this increase cause?

Answer 3

If government increases government spending on education by $ 20 billion the exact amount by which consumption will increase depends on what the MPC is. Assuming MPC is denoted by the fraction
, total spending will increase by (in billions)
Of this, the amount that will be allocated to consumption alone is the fraction
.
Therefore, the additional consumption this increase causes will be (in billions)
So, if for example we assume that
= 0.75, then the increase in total spending can be calculated (in billions) as:
Now since the MPC is 0.75, of this increase in spending, 75 percent is spent on consumption expenditure. Therefore, the amount of this increase in spending that is spent on consumption is:
Therefore, given a hypothetical MPC of 0.75 if the government increases spending by $20 billion, consumption spending increases by $60 billion.

Question 4

How long does the multiplier process take? How many cycles are likely to occur in a year's time? How will this alter the impact of fiscal policy?

Question 5

By how much would the 2008 tax rebates have shifted AD if the MPC was 0.90? (see Headline, p. 263).

Question 6

Do fiscal policymakers really need to know the magnitudes of the MPC and multipliers? Could they get along as well without such information?

Question 7

If taxes were cut by $1 trillion and the MPC was 0.80, by how much would total spending
( a ) Increase in the first year with two spending cycles?
( b ) Increase over five years, with two spending cycles per year?
( c ) Increase over an infinite time period?

Question 8

If the guidelines for fiscal policy (Table 12.2) are so simple, why does the economy ever suffer from unemployment or inflation?

Question 9

How much would AD eventually increase with Obama's increased appropriations spending (Headline, p. 257) if consumers had an MPC of 0.9?

Question 10

At the end of 2009 businesses bought more inventory, increasing GDP. What would happen if consumers didn't buy those goods?

Question 11

What was the short-run (1 month) MPC for the 2008 tax rebates (Headline, p. 263)?

Question 12

What did consumers buy with their 2008 tax rebates (Headline p. 263? Why did food purchases increase so little?

Question 13

What are the factors in the Headline on p. 253 that might depress consumer spending? How do they affect spending?

Question 14

Would a constitutional amendment that would require the federal government to balance its budget (incur no deficits) be desirable? Explain.

Question 15

If the marginal propensity to save is 0.05, how large is the multiplier? If the marginal propensity to save doubles to 0.10, what happens to the multiplier?

Question 16

How long does it take you to spend any income you receive? What happens to the dollars you spend?

Question 17

If the MPC were 0.9, how much spending would occur at step 5 in Figure 12.6? How many spending rounds would occur before consumer spending increased by $300 billion?

Question 18

What is your MPC? Would a welfare recipient and a millionaire have the same MPC? What determines a person's MPC?