6. The multiplier effect

Consider a hypothetical economy. Households spend $0.90 of each additional dollar they earn and save the remaining $0.10. The multiplier for this economy is Suppose government purchases, G , in this economy decrease by $200 billion. The decrease in G will lead to a decrease in income, generating a decrease in consumption that decreases income yet again, and so on. Fill in the following table to show the impact of the change in G on the rst two rounds of consumption spending and, eventually, on national income. Note: Use negative signs if numbers are negative. Change inG = $200 billion First Change in Consumption = $ billion Second Change in Consumption = $ billion 0 O O O O C Total Change in Income = $ billion Now consider the impact of a similar change in taxes. The (absolute value) of the tax multiplier in this question will be ; thus, if taxes change by -$200 billion, spending will change by $ billion