Presentation on theme: "Unit 3: Aggregate Demand and Supply and Fiscal Policy"— Presentation transcript:
1 Unit 3: Aggregate Demand and Supply and Fiscal Policy 1
2 ReviewIdentify the two types of tool boxes the government has to fix the economyExplain and give examples of Expansionary Fiscal PolicyExplain and give examples of Contractionary Fiscal PolicyExplain the Multiplier EffectExplain how to calculate the spending multiplierName 10 University Mascots2
3 Draw and PracticeCongress uses discretionary fiscal policy to the manipulate the following economy (MPC = .9)LRASWhat type of gap?Contractionary or Expansionary needed?What are two options to fix the gap?How much needed to close gap?ASP2Price levelAD1AD-$5 Billion$50FE $100Real GDP (billions)3
4 Draw and PracticeCongress uses discretionary fiscal policy to the manipulate the following economy (MPC = .8)LRASWhat type of gap?Contractionary or Expansionary needed?What are two options to fix the gap?How much initial government spending is needed to close gap?ASPrice levelP1AD2AD1+$40 Billion$ $1000FEReal GDP (billions)4
6 Problems With Fiscal Policy When there is a recessionary gap what two options does Congress have to fix it?What’s wrong with combining both?Deficit Spending!!!!A Budget Deficit is when the government’s expenditures exceeds its revenue.The National Debt is the accumulation of all the budget deficits over time.If the Government increases spending without increasing taxes they will increase the annual deficit and the national debt.Most economists agree that budget deficits are a necessary evil because forcing a balanced budget would not allow Congress to stimulate the economy.
7 Paul Solomon Video: Deficit and Debt US Debt Clock
13 Additional Problems with Fiscal Policy Problems of TimingRecognition Lag- Congress must react to economic indicators before it’s too lateAdministrative Lag- Congress takes time to pass legislationOperational Lag- Spending/planning takes time to organize and execute ( changing taxing is quicker)Politically Motivated PoliciesPoliticians may use economically inappropriate policies to get reelected.Ex: A senator promises more welfare and public works programs when there is already an inflationary gap.
14 Additional Problems with Fiscal Policy 3. Crowding-Out EffectIn basketball, what is “Boxing Out”?Government spending might cause unintended effects that weaken the impact of the policy.Example:We have a recessionary gapGovernment creates new public library. (AD increases)Now but consumer spend less on books (AD decreases)Another Example:The government increases spending but must borrow the money (AD increases)This increases the price for money (the interest rate).Interest rates rise so Investment to fall. (AD decrease)The government “crowds out” consumers and/or investors
15 Additional Problems with Fiscal Policy 4. Net Export EffectInternational trade reduces the effectiveness of fiscal policies.Example:We have a recessionary gap so the government spends to increase AD.The increase in AD causes an increase in price level and interest rates.U.S. goods are now more expensive and the US dollar appreciates…Foreign countries buy less. (Exports fall)Net Exports (Exports-Imports) falls, decreasing AD.
18 Congressional Committees As a group, analyze the situation, identify the problem, and identify your solutionThe Good, the Bad, and the UglyUnemploymentInflationGDP GrowthGood6% or less1%-4%2.5%-5%Worry6.5%-8%5%-8%1%-2%Bad8.5 % or more9% or more.5% or less
19 1.) 1933 Situation: GDP fell -1.2% Inflation rate= -.5% Unemployment Rate=25%Your Solution:What actually happened:FDR increased public works via the New Deal programs.
20 2.) 1944 Situation: GDP grew 8% Inflation rate= 3.7% Unemployment Rate=1.2%Your Solution:What actually happened:War ended the next year and government orders for war materials decreased.Many public works programs were discontinued
21 3.) 1980 Situation: GDP fell -0.3% Inflation rate= 13.5% Unemployment Rate=7.1%Your Solution:What actually happened:The next year, President Regan and congress lowered taxes on individuals and corporations by about 30%. (Supply-side Economics)
22 4.) 2003 Situation: GDP fell 0.5% Inflation rate= 1.5% Unemployment Rate=12.0%Your Solution:What actually happened:Congress voted to give tax cuts to citizens. (Bush Tax Cuts)