Fiscal policy is the government's use of spending, taxes, and transfer payments to shift aggregate demand. Start from a recessionary or inflationary gap, pick a tool and an amount, and the lab uses the multipliers to show how far AD shifts. Then check whether your policy closes the gap, falls short, or overshoots.
AP calculation questions treat the multiplier result as the change in real GDP. The graph is a sketch: it places the new equilibrium at that real GDP, and because SRAS slopes up, the price level also rises. Dashed grey lines show where the economy started.
Expansionary fiscal policy raises government spending, cuts taxes, or raises transfers. AD shifts right, real GDP and the price level rise. Use it for a recessionary gap. Contractionary fiscal policy does the opposite. AD shifts left, real GDP and the price level fall. Use it for an inflationary gap.
Government spending is part of AD, so every dollar counts in the first round: spending multiplier = 1/MPS. A tax cut or transfer first raises disposable income, and households spend only the MPC share of it. That skips one round, so the tax multiplier is −MPC/MPS and the transfer multiplier is MPC/MPS.
To find the change in a tool that closes a gap, divide the gap by that tool's multiplier. A $200 billion recessionary gap with MPC 0.75 needs a $50 billion increase in G (200 ÷ 4) or a tax change of 200 ÷ (−3) = −$66.7 billion, a tax cut.
Discretionary fiscal policy is a deliberate decision by lawmakers, such as passing a spending bill or a tax cut. Automatic stabilizers (topic 3.9) change on their own as income rises and falls. The central bank does not run fiscal policy; that is monetary policy.
Policy lags are delays. The recognition lag is the time it takes to see the problem. The decision lag is the time lawmakers need to agree. The implementation lag is the time before the money is spent and affects AD. By the time a policy hits, the gap may have changed, so it can overshoot.
Budget balance = tax revenue − government spending − transfers. Expansionary policy moves the budget toward a budget deficit (a bigger deficit or smaller surplus). Contractionary policy moves it toward a budget surplus. Raising G and taxes by the same amount leaves the balance unchanged but still shifts AD right, because the balanced-budget multiplier is 1.
Each row uses the same three steps: find MPS, find the multiplier, then divide the gap by the multiplier. A minus sign on a tax change means a tax cut.
| Starting gap | MPC | Spending multiplier (1/MPS) | Tax multiplier (−MPC/MPS) | ΔG needed | ΔT needed | ΔTransfers needed | Budget balance moves toward |
|---|---|---|---|---|---|---|---|
| $200B recessionary | 0.75 | 4 | −3 | +$50B | −$66.7B | +$66.7B | Deficit |
| $100B recessionary | 0.8 | 5 | −4 | +$20B | −$25B | +$25B | Deficit |
| $300B recessionary | 0.5 | 2 | −1 | +$150B | −$300B | +$300B | Deficit |
| $90B inflationary | 0.9 | 10 | −9 | −$9B | +$10B | −$10B | Surplus |
| $120B inflationary | 0.6 | 2.5 | −1.5 | −$48B | +$80B | −$80B | Surplus |
AP-style multiple choice. Pick an answer to see the explanation.
The vocabulary for topic 3.8. Read the list, flip through flashcards, or quiz yourself. For every term in the unit, see the Unit 3 terminology guide.