Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 27: Problem 2

Define government purchases multiplier and tax multiplier.

Short Answer

Expert verified
The government purchases multiplier is the larger change in aggregate output caused by an initial change in government purchases, and is calculated as the inverse of (1 – the economy's marginal propensity to consume). The tax multiplier, on the other hand, is the change in aggregate output caused by a change in taxation, and is calculated as the marginal propensity to consume minus one.

Step by step solution

01

Define Government Purchases Multiplier

The government purchases multiplier is the concept in economics that suggests that an initial change in government purchases (increased or decreased spending) leads to a larger change in aggregate output (or Gross Domestic Product - GDP). It is calculated as the inverse of (1 – the economy's marginal propensity to consume). Hence, its formula is \( \frac{1}{(1 - marginal propensity to consume)} \). An increase in government spending initially boosts the economy which then circulates in the economy leading to an increase in income and further consumption.
02

Define the Tax Multiplier

The tax multiplier is the ratio of change in aggregate output or GDP to the change in government tax revenues, when all other factors are held constant. Simply put, it is the change in output stimulated by changes in taxation. The tax multiplier is calculated as the marginal propensity to consume minus one. Hence, its formula is \( (marginal propensity to consume - 1) \). An increase in taxes effectively reduces disposable income, thus reducing consumption and, by extension, aggregate output.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

Economist Mark Thoma observed, "One of the difficulties in using fiscal policy to combat recessions is getting Congress to agree on what measures to implement.... Automatic stabilizers bypass this difficulty by doing exactly what their name implies." What are automatic stabilizers? Name two examples of automatic stabilizers and explain how they can reduce the severity of a recession.

An article in the Wall Street Journal discussing the Trump administration's goal of increasing the annual rate of growth in real GDP to 3 percent noted, "Two stubborn obstacles stand in his way. The work force isn't producing enough new workers, and the productivity of those working isn'\operatorname{tg} r o w i n g ~ f a s t ~ e n o u g h . " ~ B r i e f l y ~ e x p l a i n ~ w h y ~ t h e s e ~ two factors are "obstacles" to attaining a higher growth rate.

Why does a higher income tax rate reduce the multiplier effect?

What is the cyclically adjusted budget deficit or surplus? Suppose that real GDP is currently at potential GDP, and the federal budget is balanced. If the economy moves into a recession, what will happen to the federal budget?

Why do few economists believe it would be a good idea to balance the federal budget every year?
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free