Policies for economic stability and growth

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categorie: Economie

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Fiscal policy can be used to combat both unemployment caused by insufficient aggregate demand and inflation caused by too much demand. In either case, fiscal policy is more effective as a result of the multiplier effect.
The Multiplier is the multiple by which an initial change in aggregate spending will alter total spending after an infinite number of spending cycles. In other words, it re[...]
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Fiscal policy can be used to combat both unemployment caused by insufficient aggregate demand and inflation caused by too much demand. In either case, fiscal policy is more effective as a result of the multiplier effect.
The Multiplier is the multiple by which an initial change in aggregate spending will alter total spending after an infinite number of spending cycles. In other words, it refers to the magnified impact on national income of an initial increase or decrease in spending.

The multiplier process represents the sequence of spending adjustments after operating an initial cutback or a hike in income and production. The multiplier process takes time to work and it usually takes several months before the major part of the effect is completed. The multiplier process works until the initial change in income and spending becomes so small that the market behaviour remains unaffected.
The multiplier effect is based on the assumption that, on average, people "use" a certain fraction of their income for savings and taxes.

The smaller the amount will be put into savings and taxes each round of spending, the larger will be the number of rounds and finally, the multiplier. The multiplier is thus computes as:
For example, an initial injection (spending increase) of $100 (when leakage in savings and taxes is 20%) will multiply through the community until it generates an additional $400 to consumption (C), table 2.Table 2: The Multiplier Effect - The initial spending increase is of $100.

The multiplier mechanism and its effects may similarly explain how an additional $100 investment, that is a direct impact of $100 increase in national product, induces $400 in consumption and, finally, a $500 increase in national product (figure4.3. and table 3). The figure portrays the various rounds of spending that result from an initial increase of $1090 in investment in round 1; the $100 spent for plant and equipment goes in the form of wages, rents, profits and, in a word, increased income to those who provide the resources to produce capital goods.

Consumers will spend most of these increases income according to their marginal propensity to consume (MPC), or will save them according to their marginal propensity to save (MPS). If the later is 20%, in the second round $80 will be consumed and $20 will be saved. When consumers spend $80 more for clothing, food, a.s.o., the $80 in spending becomes income for producers. With a marginal propensity to save of 20%, producers will spend $64 and save $16. Once more, the national product has risen this time by $64. The story goes on and on, with each round of consumer spending giving rise to another smaller round.
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