Macro Chapter 11
Fiscal Policy
Quick Review #1
• Answer: E
Quick Review #2
If higher US interest rates cause foreign demand for the dollar to increase
which of the following will occur to the international value of the dollar
and to US exports?
International Value of the Dollar
Exports
•A. Increase
Increase
•B. Increase
Decrease
•C. Increase
No Change
•D. Decrease
Increase
•E. Decrease
Decrease
Answer: B
Quick Review #3
• 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
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
Fiscal Policy and the
AD-AS Model
Expansionary Fiscal Policy
Full $20 Billion
Increase in
Aggregate Demand
Price Level
$5 Billion
Additional
Spending
AS
Recessions
Decrease
Aggregate
Demand
P1
AD1
AD2
$490
$510
Real Domestic Output, GDP
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
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
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
2. Increased Taxes
• Reduces consumption spending since
people will have less disposable income
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
Fiscal Policy and the
AD-AS Model
Contractionary Fiscal Policy
Recessions
Decrease
Aggregate
Demand
$5 Billion
Initial Decrease
In Spending
Price Level
AS
Full $20 Billion
Decrease in
Aggregate Demand
P1
AD4
AD3
$510
$522
Real Domestic Output, GDP