November, 2011 | The Economics Classroom

Fiscal Policy – the Tax Multiplier

This is part two of the lessons on the multiplier effects of fiscal policy. The first lesson explained how the Keynesian Spending Multiplier could be found using the marginal propensities to consume and save. Watch that video here before watching the one below.

This lesson illustrates how a tax cut of a particular amount will ultimately affect aggregate demand in the economy and therefore total output. Tax cuts are an indirect injection into the macro-economy, meaning that they put money into the pockets of households, but who then get to decide how much of it to spend on goods and services. For this reason, the tax multiplier is generally thought to be smaller than the spending multiplier. What does this mean for fiscal policy-makers? When considering the possible expansionary effects of a particular tax cut or government spending package, it should be acknowledged that tax cuts, may not provide the level of stimulus as government spending, since some of a tax cut will be saved rather than spent.

 

Fiscal Policy – the Government Spending Multiplier

This video will introduce and explain the effect of an expansionary fiscal policy on aggregate demand, specifically an increase in government spending. When government spending increases, household incomes rise and therefore consumption increases, further adding to the expansionary effect on Aggregate Demand. If we know the marginal propensity to consume among a nation’s households, we can calculate the size of the spending multiplier, and thereby determine how much of a stimulus would be needed to increase AD by a particular desired amount.

Once you’ve watched the video, read and respond to the discussion questions for one of the following blog posts:

Introduction to Fiscal Policy – Expansionary vs. Contractionary Policies

This video lesson will introduce the use of fiscal policies by a government aimed at expanding or contracting the level of economic activity in the nation. Changing the amount of government spanding and taxation can influence several macroeconomic variables, such as employment, price levels and the level of output.

When should a government alter the level of taxes and spending it engages in? This lesson will introduce two circumstances under which fiscal policy may be used to promote the achievement of various macroeconomics objectives.

 

Calculating the Effects of Price Controls

This lesson applies linear equations for demand and supply to our analysis of the effects of price controls. We can determine the precise surplus that will result from a price floor or the shortage that results from a price ceiling by applying the government set prices to the equations for supply and demand.

Before watching this video students should view the lesson that introduces price controls, Determining the Effects of Price Ceilings nad Price Floors.

 

Determining the Effects of Price Ceilings and Price Floors

This video lesson examines the effect of two types of government interventions in the markets for particular goods. Price ceilings and price controls consist of maximum or minimum prices imposed by government, intended to help either the consumers or the producers of particular goods. Like many forms of government intervention, price controls have unintended consequences that usually make them inefficient, and reduce total welfare in affected markets.

In this lesson we will look at two real world examples of price controls: the market for butter in Europe, in which European governments enforce a price floor intended to help butter producers, and the market for petrol in China, in which the Chinese government enforces a price ceilings meant to help consumers. Once you have watched the videos, follow the links below two blog posts about these two examples, and respond to the discussion questions at the end of the posts.

 

Price controls on the blog:

  1. The problem with price controls in Europe’s agricultural markets
  2. Price controls in the Chinese Petrol market – or why you may have to wait in line to fill your gas tank!

The J-Curve – Illustrating the Marshall Lerner Condition

This video lesson is part two of a lesson on the Marshall-Lerner Condition and the J-curve. Before watching this video, make sure you have watched the lecture on the Marshall-Lerner Condition.

This lesson will explain how a depreciation of a nation’s currency is likely to affect the nation’s current account balance in the short-run and in the long-run depending on the price elasticity of demand for exports and imports.

After watching the video, read and respond to the discussion questions in the following blog post: The Marshall-Lerner Condition, the J-curve, and the US trade deficit

There is also an in-class research assignment to accompany this lesson. We will do this in my class with HL students over the next two class periods. Elasticity, exchange rates and the balance of payments – understanding the Marshall Lerner Condition

 

The Marshall-Lerner Condition

This video explains the Marshall-Lerner Condition for determining whether a depreciation of a nation’s currency will improve or worsen its current account balance. The MLC is an application of the total revenue test of price elasticity of demand, and applies to the sections of the Econ course on Balance of Payments and Exchange Rates.

After watching the video, read and respond to the discussion questions in the following blog post: The Marshall-Lerner Condition, the J-curve, and the US trade deficit

There is also an in-class research assignment to accompany this lesson. We will do this in my class with HL students over the next two class periods. Elasticity, exchange rates and the balance of payments – understanding the Marshall Lerner Condition

 

Calculating the Effects of a Subsidy

This lesson explains how to calculate the effects of a per unit subsidy in a commodity market (in this case corn) using linear demand and supply equations. By employing demand and supply equations, we can determine how a per unit subsidy will effect supply, and then we can calculate the new equilibrium price and quantity. To extend our analysis, we can calculate the increase in consumer and producer surplus, the total cost to taxpayers of the subsidy, and thereby the net cost of the subsidy to society as a whole.

 

The Effects of a Subsidy on Market Equilibrium

This video lesson illustrates and explains the effects that a per unit subsidy will have on the market for a commodity, in this case, corn. The payment to producers from government lowers the marginal cost of production, increases supply and leads to lower prices for consumers and greater revenues for producers. However, subsidies are not always economically efficient, since as we will see, the cost to taxpayers may outweigh the benefit to producers and consumers, meaning a subsidy may result in a net loss of societal welfare.

 

Examining the effect of an excise tax on an inelastic good – Cigarettes

This video lesson explains how a specific excise tax will affect the equilibrium price and quantity in the market for cigarettes, which is used to represents a good for which demand is relatively inelastic. We will also explain how the tax burden is shared by both producers and consumers, and the portion of the tax born by consumers depends on the elasticity of demand for the product.

 

A Quiz on Exchange Rate Manipulation

These two videos demonstrate the solutions to two questions on a quiz I recently gave my year 2 IB Economics students on exchange rates. Before you watch the videos, consider attempting the quiz yourself. It can be downloaded here: Exchange Rates Quiz

The explanations are done in two videos. Here’s the explanation for Quiz question #1:

And here’s the explanation for #2: