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C = Consumption
I = Investment
G = Government Expenditure
( X M ) = Net Exports ( that is, exports imports)
Multiplier
Mpc = c y
1 1mpc
1
1mpc
1
10.75
1
= 0.25
=4
If MPC= 0.8
Income multiplier= 1/1-MPC
= 1/1-0.8
= 1/0.2
=5
Therefore, Total change in spending = multiplier X new spending injection
=5 X 200
= $1000 billion
Aggregate demand increases by $1000 billion
If MPC= 0.6
Income multiplier= 1/1- MPC
=1/1-0.6
=1/0.4
=2.5
Therefore, Total change in spending = multiplier X new spending injection
=2.5 X 200
= $500 billion
Aggregate demand increases by $500 billion
Therefore , 1.if MPC is less, then increase in Aggregate demand will be less
2. If MPC is more, then increase in aggregate demand will be more
1 1mpc
Mpc = c y
Total change in AD = Multiplier X Initial Increase in Consumption.
Q 01)
Tax has fallen by 200 Billion and Disposable Income increase by 200 billion.
Mpc = 75%. Find out the total change in AD?
Solution :
Initial increase in consumption = mpc X Increase in Disposable income
=
Multiplier =
1
1mpc
75
100
X 200
= 150 Billion
1
10.75
1
= 0.25
=4
= 100 X 200
Multiplier =
=
1
1mpc
= 150 Billion
1
10.75
1
= 0.25
=4
AD shortfall
Multiplier
Eg :
If AD shortfall is 800 Billion and Multiplier is 4. Find out the desired fiscal
stimulus.
Solution :
AD shortfall
Multiplier
800
4
= 200Billion
Increasing in government expenditure by 200 billion will help to
generate total 800 billion AD.
2. FISCAL RESTRAINT
If the economy is suffering from inflation, objective of fiscal authorities is to
decrease aggregate demand. Fiscal authorities have to provide fiscal restraint (any
fiscal activity which decreases the aggregate demand) by decreasing the
government spending on purchases, by increasing tax and by decreasing income
transfers.
1. Decreasing the Government Expenditure.
Government has to reduce the purchase (goods and services.)
Therefore the Income of the people will decrease and will they will
spend less.
Multiplier = 1/ 1-mpc
Cumulative fall in AD = Multiplier X Initial budget cut
Q1)
Decreasing in Government expenditure by 200 Billion and mpc = 0.75
Solution :
Income Multiplier =
=
1
1mpc
1
10.75
1
= 0.25
=4
1 1mpc
Mpc = c y
Q 01)
Increasing in Tax by 100 Billion and Initial decrease in consumption is 75 billion.
(Mpc = 75%). Find out the total change in AD?
Solution :
1
1mpc
Multiplier =
=
1
10.75
1
= 0.25
=4
Income transfers decreased by 200 Billion and mpc is 75% (0.75). Find out the
total fall in AD .
Solution :
Fall in initial consumption = mpc X Fall in disposable income
75
= 100 X 200
Multiplier =
=
1
1mpc
= 150 Billion
1
10.75
1
= 0.25
=4