Unit 12: Fiscal Policy
How a government's own spending and tax decisions ripple through the whole economy multiplied, and what a decade of deficits leaves behind.
8 topics · 29 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
The Marginal Propensity to Consume and Save
- How it worksHow do the marginal propensity to consume and the marginal propensity to save split up every new dollar of income?
- Worked exampleFind the marginal propensity to consume when disposable income rises by 500 dollars and consumption rises by 400 dollars.
- Common mistakeWhy isn't a high household saving rate automatically good for total output in the short run?
Your turn1 of 2
Find the marginal propensity to consume when disposable income rises by 709 dollars and consumption rises by 399 dollars.Deriving the Spending Multiplier
- How it worksWalk me through the rounds of respending, each one smaller than the last, that turn 100 billion dollars into 400 billion dollars of output.
- How it worksHow does summing that shrinking geometric series of respending rounds produce the formula 1 divided by 1 minus the marginal propensity to consume?
- Worked exampleFind the spending multiplier and the resulting change in GDP when the marginal propensity to consume is 0.75 and government spending rises by 250 billion dollars.
- Common mistakeWhy doesn't the multiplier keep multiplying forever into an infinite amount of extra output?
- Going furtherWhat happens to the size of the multiplier when a large share of every extra dollar households earn gets spent on imports?
Your turn1 of 2
Find the resulting change in GDP when the marginal propensity to consume is 0.744 and government spending rises by 230 billion dollars.The Tax Multiplier
- How it worksHow does the first round of a tax cut leak into saving before a single extra dollar gets spent?
- Worked exampleFind the change in GDP produced by a 200 billion dollar tax cut when the marginal propensity to consume is 0.8.
- Common mistakeWhy isn't the tax multiplier simply the negative of the spending multiplier?
Your turn1 of 2
Find the change in GDP produced by a 239 billion dollar tax cut when the marginal propensity to consume is 0.727.Sizing a Fiscal Policy Response to an Output Gap
- How it worksHow does the size of the multiplier decide exactly how large a spending increase needs to be to close a given gap?
- Worked exampleFind the government spending increase needed to close a 600 billion dollar recessionary gap when the marginal propensity to consume is 0.8.
- Common mistakeWhy isn't the spending increase needed to close a gap simply equal to the size of the gap itself?
Your turn1 of 2
Find the government spending increase needed to close a 479 billion dollar recessionary gap when the marginal propensity to consume is 0.727.The Paradox of Thrift
- How it worksHow does one household's extra saving become another household's lost income once spending falls across the whole economy?
- Common mistakeWhy isn't saving more always good for an economy, the way it is almost always good for one individual household?
- Going furtherWhat happens to the paradox of thrift once an economy is already running at full employment rather than sitting in a recession?
Your turn1 of 2
When households collectively cut consumption by 120 billion dollars, and the spending multiplier is 1 divided by 1 minus the marginal propensity to consume, with MPC equal to 0.727, by how much does GDP fall in total?Automatic Stabilizers
- How it worksHow do unemployment benefits and a progressive tax code soften a recession all on their own, with no new legislation?
- Common mistakeWhy aren't automatic stabilizers the same thing as discretionary fiscal policy?
- Going furtherWhat happens to the budget deficit automatically the moment an economy slides into a recession?
- Ties togetherHow do automatic stabilizers shrink the effective multiplier on any shock that hits the economy?
Your turn1 of 2
Find the change in tax revenue when GDP falls by 309 billion dollars and the tax rate is 25 percent.Lags in Discretionary Fiscal Policy
- How it worksWalk me through recognition, decision, and implementation lags laid out along a business cycle timeline.
- Common mistakeWhy doesn't a correctly designed policy guarantee a correct result once it actually reaches the economy?
- Going furtherWhat happens when a policy built to fight a recession instead lands squarely during the recovery?
Your turn1 of 2
Congress designs a fiscal stimulus package using sound economic theory and careful analysis of the recession it targets. Can a correctly designed policy still land on an economy it no longer fits?Deficits, Debt, and the Debt-to-GDP Ratio
- How it worksHow does a run of annual deficits accumulate year after year into a growing national debt?
- Worked exampleFind the national debt after deficits of 1.1, 1.4, and 0.9 trillion dollars, starting from a debt of 28 trillion dollars.
- Common mistakeWhy doesn't the national debt need to be paid off in full the way a household pays off a credit card?
- Going furtherWhat happens to the debt-to-GDP ratio when an economy's GDP grows faster than its debt does?
- Ties togetherHow does today's government borrowing connect through crowding out to a smaller capital stock a generation from now?
Your turn1 of 2
Find the national debt after deficits of 1.287, 1.254, and 1.153 trillion dollars, starting from a debt of 27 trillion dollars.