Macro Chapter 11 Fiscal Policy. Quick Review #1 Answer: E.
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Transcript of Macro Chapter 11 Fiscal Policy. Quick Review #1 Answer: E.
Quick Review #2
• Which of the following transactions would represent an addition to a nation’s current gross domestic product?
• A. Ms. Smith purchases a share of stock in an automobile company
• B. A retailer increases her stock of imported shoes• C. The government increases its domestic purchases
of food for use by the military• D. A corporation sells shoes from last year’s inventory• E. A mother sells her car to her daughter• Answer: C
Quick Check #3
• Goods and services that are purchased for resale or for further processing or manufacturing
• Intermediate Goods
Quick Check #4
• When unemployed people lack the skills or education, or geographically are misplaced to find work
• Structural Unemployment
Council of Economic Advisors (CEA)
• Group of 3 economists appointed by the President to advise him on economic policy- mostly professors of economics
• Obama and former
Chr. Austin Goolsbee
Fiscal Policy
• Fiscal = “Financial”
• Changes in government spending and taxation designed to achieve full employment, control inflation, and encourage economic growth
Expansionary Fiscal Policy
• Used during a recession to stimulate the economy
Government has 3 Choices:
1. Increase government spending
2. Reduce taxes
3. Combo of both
1. Increased Gov’t Spending
• Ceteris Paribus, an increase in govt spending will shift the AD to the right
• New spending on highways, schools, etc. will lead to more GDP
• ***the multiplier leads to an even greater increase in demand
Fiscal Policy and theAD-AS Model
Real Domestic Output, GDP
Pri
ce L
evel
AD1
RecessionsDecreaseAggregateDemand
AD2
$5 Billion AdditionalSpending
Full $20 Billion Increase in
Aggregate Demand
AS
$490 $510
P1
Expansionary Fiscal Policy
2. Reduce Taxes
• Reducing taxes will also shift the AD curve to the right
• ***Tax cuts must be greater than the increase in govt spending to achieve the same shift in GDP due to people saving part of a tax cut
Tax Cuts and Real GDP
• 1. Change in GDP = tax cut (MPC) x multiplier
• 2. Tax Multiplier = -MPC/MPS
Reduced Taxes Example
• If the govt cuts taxes by $6.67 Billion and the MPC is .75, what is the total change in GDP?
• 6.67 x .75 = $5 billion consumed, and $1.67 B saved
• $5 B x 4 (multiplier 1/.25) = increase of $20 B in GDP
3. Combo of Govt Spending and Tax Cuts
• Ex- $1.25 B in increased government spending and $5 B tax cut with an MPC of .75
• Govt spending = 1.25 x 4 = $5 B• Tax Cut = 5 x .75 = $3.75 B increase x 4 = $15 • $5 B + $15 B = $20 B increase in GDP
Contractionary (Restrictive) Fiscal Policy
• Used to fight inflation
• 3 Options:
• 1. decrease govt spending
• 2. raise taxes
• 3. combo of the two
1. Decreased Govt Spending
• Decreased spending shifts the AD curve to the left
• If prices are inflexible downwards, this policy will stop the inflation rather than return to original price level
3. Combo Reduced Spending and Tax Increase
• Ex- $2 B decline in spending coupled with a $4 B increase in taxes (MPC of .75)
• Spending = 2 x 4 (multiplier) = $8 B
• Taxes = 4 x .75 = 3 x 4 (multiplier) = $12 B
• $8 B + $12B = decrease of $20 B in GDP