1 Fiscal Policy Key Concepts Key Concepts Summary ©2005 South-Western College Publishing.
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Transcript of 1 Fiscal Policy Key Concepts Key Concepts Summary ©2005 South-Western College Publishing.
1
Fiscal Policy
• Key Concepts• Summary
©2005 South-Western College Publishing
2
What does this chapter cover?
You will study demand-side and supply-side fiscal policies.
3
What is a discretionary fiscal policy?
The deliberate use of changes in government spending or taxes to alter aggregate demand and stabilize the economy
4
What are examples of expansionary
fiscal policy?• Increase government spending
• Decrease taxes• increase government spending and taxes equally
5
What are examples of contractionary
fiscal policy?• Decrease government spending
• Increase taxes• Decrease government spending and taxes equally
6$6 $6.1 $6.2
AS
0
150
155
AD1
AD2
Real GDP
E2
XE1
155
Government Spending to Combat a Recession
Pri
ce L
evel
full employment
7
Increase in government
spending
Increase in the aggregate
demand curve
Increase in the price
level and the real GDP
8
With an MPC of 0.75, what is the spending
multiplier?
1/MPS = 1/1/4 = 4
9
How much will real GDP increase by with
an increase in government spending
of $50 bil?4 x $50 bil = $200 bil
10
What is thetax multiplier?
The change in aggregate demand (total spending) resulting from an initial change in taxes
11
What happens when government cuts taxes by $50 bil?
The multiplier process is less because initial spending increases only by $38 bil instead of $50 bil
12
What is the formula for the tax multiplier?
1 – spending multiplier
13
How much does real GDP increase by with a cut in taxes of $50 bil?
3 x $50 bil = $150 bil
14
Can we assume that the MPC will remain fixed?No, it can change from one time period to another
15
Can fiscal policy be used to combat
inflation?Yes, this would happen when the economy is operating in the Classical or Intermediate range of the aggregate supply curve
16
What will happen to AD with a cut in G spending of 25 bil?
-$25 bil x 4 = -$100 bil
17$6 $6.1
AS
0
155
160
Real GDP
E2
E1
Using Fiscal Policy to Combat Inflation
E´
Pri
ce L
evel
full employment
AD1
AD2
18
Decrease in government
spending
Decrease in the aggregate
demand curve
Decrease in the price level
19
What will happen to AD with a cut in taxes of 33.3 bil?
$33.3 x -3 = -$100 bil
20
What is the balanced budget multiplier?
An equal change in government spending and taxes, which changes aggregate demand by the amount of the change in government spending
21
What is anautomatic stabilizer?
Federal expenditures and tax revenues that automatically change levels in order to stabilize an economic expansion or contraction
22
What are examples of automatic stabilizers?
• Transfer payments• Unemployment compensation• Welfare
23
What is abudget surplus?
A budget in which government revenues exceed government expenditures in a given time period
24
What is abudget deficit?
A budget in which government expenditures exceed government revenues in a given time period
25
$1,000
$750
$500
$250
$4 $6 $8
G
$2,500T
Real GDP
Bu
dg
et
def
icit
Bu
dg
et su
rplu
s
Automatic Stabilizers
Go
vern
men
t S
pen
din
g a
nd
Tax
es
26
Increase in real GDP
Tax collections fall and government
transfer payments rise
Budget offsets inflation
27
Decrease in real GDP
Tax collections fall and government
transfer payments rise
Budget offsets
recession
28
What is supply-side fiscal policy?
A fiscal policy that emphasizes government policies that increase aggregate supply
29
What is the purpose of supply-side fiscal
policies?To achieve long-run growth in real output, full employment, and a lower price level
302 4 6 8 10 12
AS
0
100
200
250
Demand-Side Fiscal Policy
Real GDPAD1
AD2
E1
E2
Pri
ce L
evel
150
full employment
31
Increase in government spending; decrease in net taxes
Increase in the aggregate demand curve
322 4 6 8 10 120
100
200
250
Supply-Side Fiscal Policy
Real GDPAD
E1
Pri
ce L
evel
150
AS1
AS2
full employmentE2
33
Decrease in resource prices; technological advances; subsidies;
decrease in regulations
Increase in the aggregate supply curve
34L1 L2
0
W2
W1
Labor DemandQ of Labor
Wag
e ra
te
E2
E1
Supply-Side Policies Affect Labor Markets
Before tax-cut labor supply
After tax-cut labor supply
35
Will an increase in taxes lead to higher
government revenues?That depends on where the economy is on the Laffer Curve
36
What is theLaffer Curve?
Puts forth the idea that increasing taxes from zero will increase tax revenues up to a certain point
37
What happens beyond a certain point?
Tax revenues begin to decline as the economic pie begins to shrink
38
Why does the economic pie begin to shrink?Workers have less incentive to work and investors have less of an incentive to invest
39Tmax
T0
R
Federal Tax Rate
Fed
eral
Tax
Rev
enu
e
A
The Laffer Curve
100%
B
C
D
Rmax
40
Key Concepts
41
• What is a discretionary fiscal policy?• What are examples of expansionary fiscal policy?• What are examples of contractionary fiscal policy?• With an MPC of 0.75, what is the multiplier?• How much will real GDP increase by with an increa
se in government spending of $50 bil?
• What is the tax multiplier?• What is the formula for the tax multiplier?• Can fiscal policy be used to combat inflation?
42
• What will happen to ad with a cut in g spending of 25 bil?
• What is the balanced budget multiplier?• What is an automatic stabilizer?• What is a budget surplus?• What is a budget deficit?• What is supply side fiscal policy?• What is the Laffer Curve?
43
Summary
44
Fiscal policy is the use of government spending, taxes, and transfer payments for the purpose of stabilizing the economy.
45
Discretionary fiscal policy follows the Keynesian argument that the federal government should manipulate aggregate demand in order to influence the output, employment, and price levels in the economy.
46
Discretionary fiscal policy requires either new legislation to change government spending or taxes in order to stabilize the economy.
47
Expansionary fiscal policy is a deliberate increase in government spending, a deliberate decrease in taxes, or some combination of these two options.
48
Contractionary fiscal policy is a deliberate decrease in government spending, a deliberate increase in taxes, or some combination of these two options.
49
Using either expansionary or contractionary fiscal policy, the government can shift the aggregate demand curve in order to combat recession, cool inflation, or achieve other macroeconomic goals.
50
• Increase government spending• Decrease taxes• Increase government spending and taxes equally
Expansionary Contractionary
Discretionary Fiscal Policies
• Decrease government spending• Increase taxes• Decrease government spending and taxes equally
51
The tax multiplier is the multiplier by which an initial change in taxes changes aggregate demand (total spending) after an infinite number of spending cycles.
52
Expressed as a formula, the tax multiplier = 1 - spending multiplier.
53
A balanced budget multiplier is not neutral. A dollar of government spending increases real GDP more than a dollar cut in taxes. Thus, even though the government does not spend more than it collects in taxes, it is still stimulating the economy.
54
Combating recession and inflation can be accomplished by changing government spending or taxes.
55
The total change in aggregate demand from a change in government spending is equal to the change in government spending times the spending multiplier. The total change in aggregate demand from a change in taxes is equal to the change in taxes times the tax multiplier.
56
Increase in government
spending
Increase in the aggregate
demand curve
Increase in the price
level and the real GDP
57
Decrease in government
spending
Decrease in the aggregate
demand curve
Decrease in the price level
58
A budget surplus occurs when government revenues exceed government expenditures.
59
A budget deficit occurs when government expenditures exceed government revenues.
60
Automatic stabilizers are changes in taxes and government spending that occur automatically in response to changes in the level of real GDP.
61
The business cycle creates braking power. A budget surplus slows down an expanding economy. A budget deficit reverses a downturn in the economy.
62
$1,000
$750
$500
$250
$4 $6 $8
G
$2,500T
Real GDP
Bu
dg
et
def
icit
Bu
dg
et su
rplu
s
Automatic Stabilizers
Go
vern
men
t S
pen
din
g a
nd
Tax
es
63
According to supply-side fiscal policy, lower taxes encourage work, saving, and investment, which shift the aggregate supply curve rightward. As a result, output and employment increase without inflation.
64
The Laffer curve represents the relationship between the income tax rate and the amount of income tax revenue collected by the government.
65
END