A contractionary fiscal policy measure, on the other hand, refers to the measure where amount of money available to the populace is decreased, and output or national income is decreased as well. This measure is composed of increasing taxation (through raised taxes) and/or the lowering of government spending. Again, if we look at equation (1), we could notice that an increase in T would lessen the amount of disposable income y-T, and consequently a lower output or national income Y. The same decreased could be noticed if government spending is decreased. A lower G would likewise result in a lower Y.
Thus, the populace is considered to be less wealthy and output or national income is likewise decreased. How much a fiscal policy change could affect output is never constant or stable. There are what we call multipliers that “increase or decrease the efficacy of fiscal policy” (Sparknotes). Since there are two fiscal policy actions, there are also two kinds of multipliers: tax multiplier and government spending multiplier. A tax multiplier is largely dependent on the marginal propensity to consume (MPC), the measurement of a “population’s willingness to consume” (Sparknotes).
A small MPC denotes “large savings and small consumption” (Sparknotes), while a large MPC denotes “small savings and large consumption” (Sparknotes). To be able to measure the actual change in output of a tax measure, that is, the tax multiplier, the following equation is used: [(+or-change in taxes) (-MPC)] / (1-MPC) (2) Hence, if there is a tax cut of let us say $10 million and the MPC is 0. 6, we would have the following computation: