Principles of Macroeconomics, Version 3.0
Libby Rittenberg & Tim Tregarthen
2.4 Changes in Business Taxes
• A change in the tax rate on corporate profits affects investment, which
in turn causes shifts in the AD curve. That means a change in the
corporate income tax rate will cause changes in the real GDP and the
price level.
2.5 Changes in Income Taxes
• A change in income taxes shifts the AD curve by a multiple of the
initial change in consumption (which is less than the change in
personal disposable income) that the change in income taxes causes.
2.6 Changes in Transfer Payments
• As with income taxes, a change in government transfer payments
shifts the AD curve by a multiple of the initial change in consumption
(which is less than the change in personal disposable income) that
the change in transfer payments causes.
Table 12.1 Fiscal Policy in the United States
Since 1964
Table 12.1 Fiscal Policy in the United States
Since 1964
3. Issues in Fiscal Policy
Learning Objectives
1. Explains how the various kinds of lags influence the effectiveness of
discretionary fiscal policy.
2. Explain and illustrate graphically how crowding out (and its reverse)
influences the impact of expansionary or contractionary fiscal policy.
3. Discuss the controversy concerning which types of fiscal policies to
use, including the arguments from supply side economics.
3.2 Crowding Out
• Crowding out: the tendency for an expansionary fiscal policy to
reduce other components of aggregate demand.
• Increased government spending raises interest rates causing less consumption
and investment.
• Crowding in: the tendency for a contractionary fiscal policy to
increase other components of aggregate demand.
• Less government spending lowers interest rates causing more consumption
and investment.
3.3 Choice of Policy
• Supply side economics: the school of thought that promotes the
use of fiscal policy to stimulate long-run aggregate supply.
• Even those who agree that fiscal policy might be useful in the shortrun may disagree on the detailed components of the policy.