3.6 Demand Management - Fiscal Policy Flashcards
What is the equation linking income, consumption and saving?
Change in income –> change in saving + change in consumption
What is “marginal propensity to save (MPS)”?
The additional saving due to an additional unit of income
What is the equation of “marginal propensity to save (MPS)”?
(Change in save / change in income)
What is “marginal propensity to consume (MPC)”?
The additional consumption due to an additional unit of income
What is the equation of “marginal propensity to consume (MPC)”?
(Change in consumption / change in income)
If the additional income is $500, and they consume $100 whilst saving $400, what is the MPC and the MPS?
MPS = 400/500 = 0.8 MPC = 100/500 = 0.2
What does “k” stand for?
Keynesian multiplier
What is the Keynesian multiplier directly proportional to?
K is directly proportional to MPC
What is the Keynesian multiplier indirectly proportional to?
K is indirectly proportional to MPS
The size of the multiplier in a CLOSED economy can be calculated in two ways:
1) 1/ MPS
2) 1/1-MPC
(THIS IS THE SAME, as 1-MPC = MPS)
The size of the multiplier in an OPEN economy can be calculated using the equation:
1/MPS + MPM + MRT
MPM = Marginal propensity to import MRT = Marginal rate of tax
What is “marginal rate of tax (MRT)”?
The proportion of additional income that is taxed
What is “marginal propensity to import (MPM)”?
The proportion of additional income that is spent on imports
Why is using the equation (1/MPS + MPM + MRT) more accurate than (1/1-MPC)?
Because (1/1-MPC) may overstate the size of the multiplier. Some of the consumption spending (MPC) is on imports, so we need to reduce this to the marginal propensity to consume domestic goods and services. To get the most accurate measure of the multiplier, we should also remove the proportion of additional income that is saved, taxed and spent on imports.
How do we calculate the change in GDP using the Keynesian multiplier?
Change in GDP = the multiplier × the change in autonomous expenditure
If a government increases spending by $100m, and the MPC is 0.2, what is the change in GDP?
( 1 / 1 - 0.2 ) x $100m = $125
What happens during “crowding out”?
Interest rate in an economy rises as government tries to borrow from domestic financial sector.
Due to this, consumptions and Investment fall - and the multiplier may not work
–> Due to crowding out of consumption and investment
The supply of quantity of loanable funds is ______ proportional
The supply of quantity of loanable funds is positively proportional (the higher the interest rate, the higher the demand)
The demand of quantity of loanable funds is ______ proportional
The demand for quantity of loanable funds is negatively proportional (the higher the interest rate, the lower the demand)
If K = 0, what is the effect?
If K = 0
–> there is no change in GDP
–> fully crowded out. Increase in government spending was cancelled out by decrease in consumption + investment
If 0< K < 1, what is the effect?
Overall still a good effect on the economy. GDP increases slightly as the fall in C + I is high, but not higher than the increase in government spending.
eg. 0.3
–> ΔGDP = 0.3 x ΔG
–> ΔGDP increases less then the ΔGovernment spending
–> C + I falling > ΔG increasing
If K = Negative value, what is the effect?
Bad effect on economy. GDP falls as the fall in C + I is greater than the increase in government spending.
eg. -2
–> ΔGDP = -2 x ΔG
–> ΔGDP falls as the fall in C+ I is greater than the increase in ΔGovernment spending
–> C + I falling >>> ΔG increasing
If K > 1, what is the effect?
Good effect on the economy. GDP increases as the increase in C + I is even greater than the increase in government spending.
eg. 3
–> ΔGDP = 3 x ΔG
–> ΔGDP increases more then the ΔGovernment spending
–> C + I increasing > ΔG increasing
