H2 Econs - An Economical Explanation Of Fiscal Policy (FP). Plus: Multiplier (K) Effect!

• Expansionary Fiscal Policy (FP) works by reducing taxes (T) and increasing government expenditure (G). 
• Lower household tax results in higher disposable income (Y), hence consumption (C) increases. 
• Lower corporate tax increases post-tax profits, hence investment (I) increases. 
• The injection of autonomous G leads to a large increase in aggregate demand (AD) and a more than proportionate increase in real National Income (Y) via the multiplier effect. (How does it start?)

A quick and easy way to rmb the full elaboration of the multiplier effect is to ask yourself these 5 questions, including the one above.

• The K effect is based on the idea that one expenditure creates income, which induces greater expenditure;  (What is it?)

• With an initial increase in C,G, & I, AD and hence real NY increases. Higher household Y leads to induced C, resulting in further increases in AD and real NY.    (How does it continue?)

• The process repeats until the initial G injected is withdrawn in the form of Taxes (T), Savings (S) and Import Expenditure (M). (How does it end?)

• Thus, an initial autonomous injection of income leads to a large increase in AD and a more than proportionate increase in real NY. With higher AD, firms face unplanned disinvestment/ fall in stocks, hence they hire more factors of production (FOPs) including labour, thus employment increases and moves towards full employment (Yf). (What is the overall effect on NY and unemployment?)

So putting it together, you have a model elaboration for FP Policies:

Expansionary Fiscal Policy (FP) works by reducing taxes (T) and increasing government expenditure (G). Lower household tax results in higher disposable income (Y), hence consumption (C) increases while lower corporate tax increases post-tax profits, hence investment (I) increases. Furthermore, the injection of autonomous G leads to a large increase in aggregate demand (AD) and a more than proportionate increase in real National Income (Y) via the multiplier (K) effect.

The K effect is based on the idea that one expenditure creates income, which induces greater expenditure. With an initial increase in C,G, & I, AD and hence real NY increases. Higher household Y leads to induced C, resulting in further increases in AD and real NY. The process repeats until the initial G injected is withdrawn in the form of Taxes (T), Savings (S) and Import Expenditure (M).

Thus, an initial autonomous injection of income leads to a large increase in AD and a more than proportionate increase in real NY. With higher AD, firms face unplanned disinvestment/ fall in stocks, hence they hire more factors of production (FOPs) including labour, thus employment increases and moves towards full employment (Yf).

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