# Balanced Budget Multiplier by yyp14196

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```									Chapter 9: The
Government
and Fiscal Policy
Outline

I. Government in the economy
II. How fiscal policy works? Multiplier effects.
1. The government spending multiplier
2. The tax multiplier
3. The balanced-budget multiplier
III. The federal budget
IV. The economy’s influence on the
government budget
I. Government in the Economy

 Government can affect the macroeconomy
in two ways:
   Fiscal policy

   Monetary policy
I. Government in the Economy

 Discretionary fiscal policy refers to
deliberate changes in taxes or spending.

 The government can not control certain
aspects of the economy related to fiscal
policy.
The Budget Deficit
 A government’s budget deficit is the difference
between what it spends (G) and what it collects in
taxes (T) in a given period:

Budget deficit  G  T
• If G exceeds T, the government must
borrow from the public to finance the
deficit. It does so by selling Treasury
bonds and bills. In this case, a part of
household saving (S) goes to the
government.
Disposable Income (Yd)
 Disposable, or after-tax, income (Yd )
equals total income minus taxes.

Yd  Y  T
Adding Net Taxes (T) and Government
Purchases (G) to the Circular Flow of Income

 When government enters the picture, the aggregate
income identity gets cut into three pieces:

Yd  Y  T
Yd  C  S
Y  T  C S
Y  C S  T
• And aggregate expenditure (AE) equals:

AE  C  I  G
Consumption Function
C  a  bYd
Yd  Y  T

C  a  b( Y  T )
 The aggregate consumption function is now a
function of disposable, or after-tax, income.
Equilibrium Output: Y = C + I + G
C  100 .75Yd                       C  100.75(Y  T )
Finding Equilibrium aggregate output for I = 100, G = 100, and T =
100 (All Figures in Billions of Dollars)

(1)     (2)        (3)              (4)             (5)       (6)        (7)          (8)         (9)           (10)
PLANNED              PLANNED   UNPLANNED
OUTPUT   NET    DISPOSABLE     CONSUMPTION         SAVING INVESTMENT GOVERNMENT AGGREGATE INVENTORY         ADJUSTMENT
(INCOME) TAXES     INCOME         SPENDING             S     SPENDING PURCHASES EXPENDITURE   CHANGE             TO
Y      T      Yd = Y  T   (C = 100 + .75 Yd)   (Yd – C)     I        G        C+I+G    Y  (C + I + G) DISEQUILIBRIUM

300    100        200              250             50       100         100           450        150       Output ↑
500    100        400              400                0      100         100           600        100       Output ↑
700    100        600              550              50       100         100           750         50       Output ↑
900    100        800              700             100       100         100           900              0   Equilibrium
1,100    100      1,000              850             150       100         100         1,050        + 50      Output ↓
1,300    100      1,200            1,000             200       100         100         1,200       + 100       Output ↓
1,500    100      1,400            1,150             250       100         100         1,350       + 150      Output ↓
Finding Equilibrium
Output/Income Graphically
The Leakages/Injections Approach
 Taxes (T) are a leakage from the flow of income.
Saving (S) is also a leakage.
 In equilibrium, aggregate output (income) (Y) equals
planned aggregate expenditure (AE), and leakages
(S + T) must equal planned injections (I + G).
Algebraically,

AE  C  I  G
Y  C S  T
C S  T  C I  G
S T  I  G
Adding Net Taxes (T) and Government Purchases
(G) to the Circular Flow of Income
II. 1. The Government Spending Multiplier

 The government spending multiplier is the
ratio of the change in the equilibrium level of
output to a change in government spending.

1
Government spending multiplier 
MPS
II. 1. The Government Spending Multiplier

Finding Equilibrium After a \$50 Billion Government Spending Increase
(All Figures in Billions of Dollars; G Has Increased From 100 in Table 25.1 to 150 Here)

(1)      (2)       (3)           (4)           (5)       (6)         (7)          (8)         (9)          (10)
PLANNED               PLANNED   UNPLANNED
OUTPUT   NET  DISPOSABLE CONSUMPTION          SAVING INVESTMENT GOVERNMENT AGGREGATE INVENTORY          ADJUSTMENT
(INCOME) TAXES   INCOME      SPENDING             S     SPENDING  PURCHASES EXPENDITURE   CHANGE             TO
Y      T   Yd = Y  T (C = 100 + .75 Yd)   (Yd – C)     I         G        C+I+G    Y  (C + I + G) DISEQUILIBRIUM

300     100       200           250           50       100         150          500        200       Output ↑
500     100       400           400              0      100         150          650        150       Output ↑
700     100       600           550            50       100         150          800        100       Output ↑
900     100       800           700          100        100         150          950         50       Output ↑
1,100     100     1,000            850          150       100         150         1,100           0      Equilibrium

1,300     100     1,200         1,000           200       100         150         1,250        + 50       Output↓
II. 1. The Government Spending Multiplier
II. 2. The Tax Multiplier

 A tax cut increases disposable income, and
Income will increase by a multiple of the
decrease in taxes.
 A tax cut has no direct impact on spending.
The multiplier for a change in taxes is smaller
than the multiplier for a change in
government spending.
II. 2. The Tax Multiplier

 1 
 Y  (initial increase in aggregate expenditure)       
 MPS 

 1              MPC 
 Y  (   T  MPC )          T       
 MPS            MPS 

 MPC 
Tax multiplier        
 MPS 
II. 3. The Balanced-Budget Multiplier

 The balanced-budget multiplier is the ratio
of change in the equilibrium level of output to
a change in government spending where the
change in government spending is balanced
by a change in taxes so as not to create any
deficit.
II. 3. The Balanced-Budget Multiplier

Finding Equilibrium After a \$200 Billion Balanced Budget Increase in G and T
(All Figures in Billions of Dollars; G and T Have Increased From 100 in Table 25.1 to
300 Here)
(1)       (2)      (3)            (4)          (5)        (6)          (7)            (8)               (9)
PLANNED              PLANNED     UNPLANNED
OUTPUT     NET  DISPOSABLE     CONSUMPTION INVESTMENT GOVERNMENT AGGREGATE        INVENTORY          ADJUSTMENT
(INCOME)   TAXES   INCOME         SPENDING        SPENDING PURCHASES EXPENDITURE     CHANGE               TO
Y        T    Yd = Y  T   (C = 100 + .75 Yd)     I        G        C+I+G      Y  (C + I + G)   DISEQUILIBRIUM

500      300      200            250          100        300           650          150            Output ↑
700      300      400            400          100        300           800          100            Output ↑
900      300      600            550          100        300           950            50           Output ↑
1,100      300      800            700          100        300         1,100                  0       Equilibriu
m
1,300      300    1,000            850          100        300         1,250           + 50           Output ↓
1,500      300    1,200          1,000          100        300         1,400         + 100            Output ↓
Fiscal Policy Multipliers

Summary of Fiscal Policy Multipliers
FINAL IMPACT
POLICY STIMULUS            MULTIPLIE        ON
R        EQUILIBRIUM Y
Government-      Increase or decrease in the
spending         level of government                1             1
G
multiplier       purchases:                        MPS           MPS

Tax multiplier   Increase or decrease in the       MPC               MPC
level of net taxes:                          T 
MPS                MPS

Balanced-        Simultaneous balanced-budget
budget           increase or decrease in the         1
multiplier       level of government purchases                       G
and net taxes:
III. The Federal Budget
 The federal budget is the budget of the
federal government.
 The difference between the federal
government’s receipts and its expenditures is
the federal surplus (+) or deficit (-).
III. The Federal Budget
Federal Government Receipts and Expenditures, 2000 (Billions of
Dollars)
PERCENTAGE
AMOUNT      OF TOTAL
Receipts
Personal taxes                                                     1,010.1        49.6
Corporate taxes                                                      193.2         9.5
Contributions for social insurance                                   720.6        35.4
Total                                                   2,034.9       100.0
Current Expenditures
Consumption                                                          514.1        26.9
Transfer payments                                                    831.9        43.6
Grants-in-aid to state and local governments                         274.2        14.4
Net interest payments                                                236.9        12.4
Net subsidies of government enterprises                               52.5         2.7
Total                                                    1,909.6       100.0
Current Surplus (+) or deficit () (Receipts  Current Expenditures)    + 125.3
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
The Federal Government Surplus (+) or
Deficit (-) as a Percentage of GDP, 1970 I2003 II
The Debt

 The federal debt is the total amount
owed by the federal government. The
debt is the sum of all accumulated
deficits minus surpluses over time.
 Some of the federal debt is held by
the U.S. government itself and some
by private individuals. The privately
held federal debt is the private (non-
government-owned) portion of the
federal debt.
The Federal Government Debt as a
Percentage of GDP, 1970 I2003 II

The percentage began to fall in the mid 1990s.
IV. The Economy’s Influence
on the Government Budget
 Automatic stabilizers are revenue
and expenditure items in the federal
budget that automatically change with
the state of the economy in such a
way as to stabilize GDP.
IV. The Economy’s Influence
on the Government Budget
 Fiscal drag is the negative effect on
the economy that occurs when
average tax rates increase because
taxpayers have moved into higher
income brackets during an expansion.
IV. The Economy’s Influence
on the Government Budget
 The full-employment budget is what
the federal budget would be if the
economy were producing at a full-
employment level of output.
IV. The Economy’s Influence
on the Government Budget
 The cyclical deficit is the deficit that
occurs because of a downturn in the
 The structural deficit is the deficit
that remains at full employment.
Review Terms and Concepts
automatic stabilizers                fiscal drag
balanced-budget multiplier           fiscal policy
budget deficit                       full-employment budget
cyclical deficit                     government spending multiplier
discretionary fiscal policy          monetary policy
disposable, or after-tax,            net taxes
income                            privately held federal debt
federal budget                       structural deficit
federal debt                         tax multiplier
federal surplus (+) or deficit (-)

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