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 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
AD2
AD1
$490
$510
Real Domestic Output, GDP
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
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
$530
Real Domestic Output, GDP