Posted: 6/9/2010 11:05:42 AM EDT
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$200 billion in government spending cuts and $70 billion in tax cuts. If all the tax cuts were given to households and spending cuts were implemented, by how much would aggregate demand shift ultimately as a result of the policy package? Assume an MPC of 0.80.
What I am thinking, is that the MPC doesnt matter it is fluff trying to trick me. I know the AD curve shifts to the right. Reason being I am not given the investment, imports, exports, portion of the AD equation. Essentially, what I can garner from this if I do use the MPC is that 270 billion is increased in AD X .8 or an increase of $216 billion dollars. |
| So, what I am having a hard time garnering is the reason for tax cuts and budget cuts both. Is this to shift the AD curve through two mediums? I know government spending has a bigger effect than taxes. However when doing the math do I do 200/multiplier of 5, thus 40 billion in decreased government spending, and $280 billion in lost tax revenue? What I don't get here, is which way this needs to go because of the fact that it should go right based upon the tax cuts but left for government spending, so do I add the effects together? I was under the impression that a government spending decrease always shifts the ad to the left, am I right? |
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The Keynesian multiplier is used when government spending is involved and has no MPC portion in it since the assumption is they will spend all the money they get.
The tax multiplier has the MPC built in due to people saving a portion of the money they have after a tax cut. I didn't really look at the numbers but a decrease in gov't spending decreases AD while a decrease in taxes increases AD. To find the total shift you just have to crunch the numbers and see which effect has the greater magnitude. Edit, I was wrong. It's been a couple weeks so I forgot. 
The formula for government purchase multiplier is delta Y/ delta G = 1 / (1-MPC) The formula for tax multiplier is delta Y/ delta T = -MPC/ (1-MPC) |
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The Keynesian multiplier is used when government spending is involved and has no MPC portion in it since the assumption is they will spend all the money they get. The tax multiplier has the MPC built in due to people saving a portion of the money they have after a tax cut. I didn't really look at the numbers but a decrease in gov't spending decreases AD while a decrease in taxes increases AD. To find the total shift you just have to crunch the numbers and see which effect has the greater magnitude. Fantastic, so the tax portion of it doesn't need to be ran through the multiplier process. I have this $200 decrease in government spending. The multiplier is 5 because of 1/1-.8. No in regards to the tax portion I did 70 x .8, which yields 56 billion in immediate effects, while 5 x 56 = $280 billion in total tax cuts through the multiplier process. So if I take this and government spending is cut by 200. $280-200 equals an AD shift of $80 billion to the right. |
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The Keynesian multiplier is used when government spending is involved and has no MPC portion in it since the assumption is they will spend all the money they get. The tax multiplier has the MPC built in due to people saving a portion of the money they have after a tax cut. I didn't really look at the numbers but a decrease in gov't spending decreases AD while a decrease in taxes increases AD. To find the total shift you just have to crunch the numbers and see which effect has the greater magnitude. Fantastic, so the tax portion of it doesn't need to be ran through the multiplier process. I have this $200 decrease in government spending. The multiplier is 5 because of 1/1-.8. No in regards to the tax portion I did 70 x .8, which yields 56 billion in immediate effects, while 5 x 56 = $280 billion in total tax cuts through the multiplier process. So if I take this and government spending is cut by 200. $280-200 equals an AD shift of $80 billion to the right. Since I screwed it up above I did the math. The government purchase multiplier is 5 meaning a 200b change in government purchases will lead to a decline of 1t in GDP. The tax multiplier is -4 meaning a 70b change will lead to an increase of 280b in GDP. The $1 Trillion minus the $280 Billion means that , ceteris paribus, The overall GDP will decrease by $720 Billion |
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The Keynesian multiplier is used when government spending is involved and has no MPC portion in it since the assumption is they will spend all the money they get. The tax multiplier has the MPC built in due to people saving a portion of the money they have after a tax cut. I didn't really look at the numbers but a decrease in gov't spending decreases AD while a decrease in taxes increases AD. To find the total shift you just have to crunch the numbers and see which effect has the greater magnitude. Edit, I was wrong. It's been a couple weeks so I forgot.
The formula for government purchase multiplier is delta Y/ delta G = 1 / (1-MPC) The formula for tax multiplier is delta Y/ delta T = -MPC/ (1-MPC) Lol Delta? so the multiplier is 5? and the tax cut portion I would do -.8/.2? Then add them together and see that the graph will shift to the right? |
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The Keynesian multiplier is used when government spending is involved and has no MPC portion in it since the assumption is they will spend all the money they get. The tax multiplier has the MPC built in due to people saving a portion of the money they have after a tax cut. I didn't really look at the numbers but a decrease in gov't spending decreases AD while a decrease in taxes increases AD. To find the total shift you just have to crunch the numbers and see which effect has the greater magnitude. Fantastic, so the tax portion of it doesn't need to be ran through the multiplier process. I have this $200 decrease in government spending. The multiplier is 5 because of 1/1-.8. No in regards to the tax portion I did 70 x .8, which yields 56 billion in immediate effects, while 5 x 56 = $280 billion in total tax cuts through the multiplier process. So if I take this and government spending is cut by 200. $280-200 equals an AD shift of $80 billion to the right. Since I screwed it up above I did the math. The government purchase multiplier is 5 meaning a 200b change in government purchases will lead to a decline of 1t in GDP. The tax multiplier is -4 meaning a 70b change will lead to an increase of 280b in GDP. The $1 Trillion minus the $280 Billion means that , ceteris paribus, The overall GDP will decrease by $720 Billion Oh great, I am trying to use my econ text which sucks and various sites on the internet. The first math I was getting was what you did, but then it just didn't make since. Hit me up when you need a membership I owe you! |
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Anyone care to translate to english for the non MBA's in the crowd? Seems like an intersting question....but a little explanation on the acronyms / variables would help The Keynesian model of macroeconomics states that government purchases increase the overall GDP due to a multiplying effect. The government spends the money, then the recipient of the money spends it, etc. providing a positive feedback that increases the GDP. There is another multiplier effect when taxes are reduced. Because citizens now have more money to spend they increase GDP. The difference that makes most people in gov't want to keep your money and take even more is based on your MPC, or marginal propensity to consume. Most people save a portion of their money. In the multipliers this is lost consumption since investment is more of a long term phenomenon. With the math set up the way it is, the government purchase multiplier is larger than the tax multiplier given the same MPC. In essence, overall GDP would increase if we had higher taxes and greater government spending. Obviously this doesn't take into account inefficiency, and long term effects of less investment but Keynes knew politicians didn't care about the long run so they would love his theories. |