102 ❯ Step 4. Review the Knowledge You Need to Score High
The tax multiplier is found by:• Tm = (D GDP)/(D taxes)
• Tm = MPC × M = MPC/MPSBalanced-Budget Multiplier
The government both collects and spends tax revenue. In a simplified model, if the dollars
spent equal the dollars collected, the budget is balanced. We have already discussed how the
spending multiplier and tax multiplier are different. A quick example of a balanced budget
policy illustrates what is called the balanced-budget multiplier.Example:
The government wants to spend $100 on a federal program and pay for it by
collecting $100 in additional taxes. The MPC = .90 in this example.Spending Effect
The spending multiplier = 10 implies that the $100 of new spending (G) creates a $1,000
increase in real GDP.Taxation Effect
The tax multiplier Tm = 9 implies that a $100 increase in taxes decreases real GDP by $900.Balanced Budget Effect
Change in real GDP = +$1,000 - $900 = +$100
So a $100 increase in spending, financed by a $100 increase in taxes, created only $100
in new GDP. The balanced-budget multiplier is always equal to 1, regardless of the MPC.
• Balanced-budget multiplier = 1❯ Review Questions
- When disposable income increases by $X,
(A) consumption increases by more than $X.
(B) saving increases by less than $X.
(C) saving increases by exactly $X.
(D) saving remains constant.
(E) saving decreases by more than $X.- Which of the following is true about the con-
sumption function?
(A) The slope is equal to the MPC.
(B) The slope is equal to the MPS.
(C) The slope is equal to MPC + MPS.
(D) It shifts upward when consumers are more
pessimistic about the future.
(E) It shifts downward when consumer wealth
increases in value.
3. Which of the following events most likely
increases real GDP?
(A) An increase in the real rate of interest
(B) An increase in taxes
(C) A decrease in net exports
(D) An increase in government spending
(E) A lower value of consumer wealth
TIPTIPKEY IDEA