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Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
Understanding Economics6thedition
by Mark Lovewell
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UnderstandingEconomics
Chapter 11
Fiscal Policy
Copyright 2012 by McGraw-Hill Ryerson Limited. ll rights reser!ed.
"theditionby Mar# Lo!ewell
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Learning $b%ecti!es&ter this chapter yo' will be able to(
1. identi&y e)pansionary and contractionary*scal policies+ which are 'sed by go!ernments
see#ing economic stability2. o'tline the m'ltiplier e,ect o& *scal policy+ as
determined by the marginal propensities tocons'mer and withdraw
. disting'ish b'dget s'rpl'ses and de*cits andtheir impact on p'blic debt and p'blic debtcharges
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tabili/ation olicies a tabili/ation policy is go!ernment policy
designed to lessen the e,ects o& the b'sinesscycle.3t can be either e)pansionary or contractionary.
4)pansionary policy attempts to red'ce'nemployment and stim'late o'tp't.
Contractionary policy attempts to stabili/eprices and red'ce o'tp't.
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
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tabili/ation olicy and the 5'sinessCycle6ig're 11.1+ age 00
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
C$78RC83$7 4973$7
ea#
8ro'gh
Long-R'n 8rend
o& otential$'tp't
:itho't stabili/ationpolicy
:ith stabili/ationpolicy
Rea
lG;
8ime
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tabili/ation olicies b tabili/ation policy can ta#e the &orm o& either
*scal policy or monetary policy.6iscal policy 'ses ta)es and go!ernment
p'rchases. 4)pansionary *scal policy in!ol!es more go!ernment
p'rchases and
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4)pansionary 6iscalolicy6ig're 11.2+ page 01
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
AS
AD0 AD1
b
a
otential $'tp't
3nitial
RecessionaryGap
Real G; 2002 = billions
>00?>00
1?0
1"0
rice
Le!e
lG;de
@a
tor+
2002A1
00
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Contractionary 6iscal olicy6ig're 11.+ age 02
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
>10>000
1B0
1?0
Real G; 2002 = billions
rice
Le!e
lG;de
@a
tor+
2002A
1
00
AS
AD0
AD1otential $'tp't
3nitial
3n@ationary Gap
d
c
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;iscretionary olicies ers's
'tomatic tabili/ers;iscretionary policy is intentional go!ernment
inter!ention in the economy. 'tomatic stabili/ers are b'ilt-in meas'res
s'ch as ta)es and trans&er payments to lessenthe e,ects o& the b'siness cycle. contracting economy decreases net ta)
re!en'es which increases spending and incomes.n e)panding economy increases net ta)
re!en'es which decreases spending and incomes.
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
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8he M'ltiplier 4,ect a8he m'ltiplier e,ect is the magni*ed impact
o& a spending change on ;.n initial spending change prod'ces income
and part o& this new income becomes newspending.
8his process is repeated with each spendingro'nd smaller than the last.
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
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8he 4,ect o& a Rise in Go!ernment'rchases6ig're 11.D+ age 0"
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
2000
1000
01st
ro'nd
2nd
ro'nd
rd
ro'nd
Later
spendingro'nds
Cycles o& pending
3ncrease
inRe
al$'
tp'
t2000
1000
01st
ro'nd
2nd
ro'nd
rd
ro'nd
Later
spendingro'nds
E00
3ncrease
in:ithdrawa
ls
=1000
=E00
=2E0
=2E0
=2E0
=2E0
=E00
=0
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8he pending M'ltiplier8he spending m'ltiplier(is the !al'e by which an initial spending change
is m'ltiplied to gi!e the total shi&t in the ;c'r!e
eF'als 1
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8he M'ltiplier 4,ect and rice Changes
6ig're 11.E+ age 0B
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
Real G; 2002 = billions>0E?>00
1"0
1E0
rice
Le!e
lG;de
@a
tor+
2002A
100
>10
AS
AD0 AD1
a b
c
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Changes in Go!ernment 'rchases
ers's 8a) Changes change in go!ernment p'rchases ca'ses an
initial spending change o& the same amo'ntand in the same direction.
ta) change has a smaller initial impact onspending and in the opposite direction.8he initial spending change is &o'nd by
m'ltiplying the ta) change by the marginal
propensity to cons'me and then re!ersing thesign o& this change.
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8he 5ene*ts and ;rawbac#s o& 6iscal
olicy 6iscal policy has two main bene*ts(3t can be &oc'sed on partic'lar regions.
3t has a relati!ely direct impact on spending.
6iscal policy has three main drawbac#s(3t is s'b%ect to delays recognition lag+ decision
lag+ impact lag.
3t is closely related to p'blic debt+ which is thetotal amo'nt owed by the &ederal go!ernmentas a res'lt o& past borrowing.
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
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8he 3mpact o& 6iscal
olicy a go!ernment is r'nning a(balanced b'dget when its e)pendit'res and
re!en'es are eF'al
b'dget s'rpl's when its re!en'es e)ceed itse)pendit'res
b'dget de*cit when its e)pendit'res e)ceed itsre!en'es
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
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8he 3mpact o& 6iscal
olicy b:hen a go!ernment has a(b'dget de*cit its debt increases by the same
amo'nt
b'dget s'rpl's its debt decreases by the sameamo'nt
3n the past the &ederal go!ernment tended tor'n b'dget de*cits.
5eca'se o& past borrowing the &ederalgo!ernment pays large p'blic debt charges.
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8he ;ebate $!er 'blic ;ebt a8hose who s'pport 'sing p'blic debt say(p'blic debt pro!ides bene*ts by red'cing the
costs o& 'nemployment
abo't >0 percent o& go!ernment debt is held byCanadians+ or owed to o'rsel!es
when debt is 'sed to create prod'cti!e assets+it is not necessarily a problem
there ha!e been times in the past when p'blicdebt as a percent o& G; was higher than now
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
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8he ;ebate $!er 'blic ;ebt b8hose against 'sing p'blic debt say(p'blic debt charges rose 'ntil recently
pro!incial and territorial debts need to be ta#eninto acco'nt as well
there are limits to how m'ch ta)es can beraised to pay p'blic debt charges
there are potential &'t're b'rdens associatedwith the crowding-o't e,ect and the amo'nt o&Canadas go!ernment debt held by &oreigners
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
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'blic ;ebt and G;6ig're + page 2E
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
1"2#-1"2$1"%#-1"%$
1"-1"&$
1"'#-1"'$
1"##-1"#$
1"$#-1"$$
1"(#-1"($
1""#-1""$200#-200$
2010-2011
2.%%.1
12.$
11.&
1$.$
&1.'
2'$.$
'#2."$.%
''#.&
#$
10$
%'
2$
21
'0
#$%2
%&
2.'%.0
%."
1.'
1.(
2.&
'.#
'.#2.%
1."
Year Public Debt(billions of
current-year $)
Public Debt(% of
nominal GDP)
Public DebtCharges (% ofnominal GDP)
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8he 3mpact o& Go!ernment $LCa
:hen go!ernment is incorporated in theaggregate e)pendit'res model+ we ass'methat 8 is a l'mp-s'm amo'nt o& =200 billion at
e!ery G; le!el. Li#ewise G is =200 billion.:hile G is added directly to the 4 line+ the
e,ect o& ta)es is indirect. :ith an MC o& .?E+a =200 billion rise is ta)es will ca'se C to &all
by =1E0 billion at e!ery G; le!el.
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8he 3mpact o& Go!ernment $LCb
ince 4 rises by =200 billion d'e to G and&alls by =1E0 billion d'e to 8+ the o!erall risein the 4 line is =E0 billion.
s a res'lt+ eF'ilibri'm G; e)pands by =200billion.
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8he 3mpact o& Go!ernment $LCc6ig're contin'ed in part e
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
0200D00"00>00
100012001D00
E0200E0E00"E0>00BE0
1100
2E2E2E2E2E2E2E2E
2E2E2E2E2E2E2E2E
00DE0"00?E0B00
10E012001E0
200 D00 "00 >00 1000 1200 1D00
0
200
D00
"00
>00
1000
1200
1D00
G; = billions
4)pen
dit'res
=billions
AE0= C0+ I + (X !
AE1= C0+ I + " +(X !
AE#= C1+ I + " +(X !
a
c
Change in
C A -=1E0b.
G A=200b.
DE
S$ending%&'t$'t A$$roac
G; C 3 9-M 4= billions
G
200200200200200200200200
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8he 3mpact o& Go!ernment $LCd
:hen go!ernment is incorporated in thein%ections-withdrawals approach+ in%ectionsrise by =200 billion.
8here are two e,ects on withdrawals(8otal withdrawals rise by =200 billion d'e to the
addition o& 8.8otal withdrawals &all beca'se o& a drop in
sa!ing. :ith an M o& .2E+ a =200 billion rise inta)es ca'ses to &all by =E0 billion.$!erall+ total withdrawals rise by =1E0 billion+
while eF'ilibri'm o'tp't e)pands.
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8he 3mpact o& Go!ernment $LCe6ig're + contin'ed &rom part c
Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.
S0+ ) +
S1+ ) +
S0+
I + X
I + " + X
Change in A -=E0b.
8 A=200b b
d
200 D00 "00 >00 1000 1200 1D00
G; = billions
0
200
D00
"00
-200
3n%ec
tions+
:ithdraw
als=billions
0
200D00"00>00
100012001D00
-2E0
-200-1E0-100-E0
0E0
100
200
200200200200200200200
200
200200200200200200200
?E
?E?E?E?E?E?E?E
E0
E0E0E0E0E0E0E0
00
E0D00DE0E00EE0"00"E0
2E
2E2E2E2E2E2E2E
In*ections%itdra,als A$$roac
G; 8 G 9= billions
M I8IM 3 3IGI9
"00
"00"00"00"00"00"00"00
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8he 3mpact o& Go!ernment $LC
8he 5alanced 5'dget M'ltiplier8he impact o& incorporating go!ernment on
eF'ilibri'm G; can be shown 'sing thebalanced b'dget m'ltiplier.8he change in o'tp't d'e to a change in both G
and 8 by the same dollar amo'nt ie. =200billion is shown by the &ollowing &orm'la(
change in o'tp't A 1 ) change in G or 8
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8he 3mpact o& Go!ernment $LCggregate ;emand and ggregate
'pply a8he aggregate e)pendit'res model can be
interpreted 'sing aggregate demand andaggregate s'pply i& we remember that in this
model the price le!el is ass'med to beconstant+ so that is hori/ontal.
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UnderstandingEconomics
Chapter 11
)e EndCopyright 2012 by McGraw-Hill Ryerson Limited. ll rights reser!ed.
"theditionby Mar# Lo!ewell
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