Demand-Side Policy: Greater Spending Means Higher Prices
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Presentation on theme: "Demand-Side Policy: Greater Spending Means Higher Prices"— Presentation transcript:
1 Demand-Side Policy: Greater Spending Means Higher Prices (c) Aggregate Demand and Supply in the classical range of AS curve. (Prices rise without significant improvements in output and employment.)Price LevelAD1ADY?Real GDP
2 Analysis of a Tax-and-Spend Policy Government increases spending, but finances it with tax increases. The increase in spending shifts AD to the right, but the increase in taxes reduces the incentive to work(???), shifting AS to the left.
3 Crowding OutGovernment Deficit Borrowing by GovernmentGovernment Demand for Credit Interest Rates UP.Higher interest rates Investment Spending DOWNPrivate investment is “crowded out” by debt-financed public (gov’t) spending.
4 Other impacts of Budget Deficits and National Debt Crowding out of private investment Future capital stock DOWN Future Output DOWN .Interest rates UP Currency Appreciation Foreign Goods Cheaper Imports UP Net Exports DOWN GDP DOWNNational Debt UP Interest paid by government UP.
8 Fiscal Policy: Some Definitions Demand-side policies: spending and tax policies designed to stimulate or slow aggregate demand.Supply-side policies: policies designed to increase productivity and enterprise.Discretionary Fiscal Policy: changes in government spending and/or taxation aimed at achieving a policy goal.Automatic Stabilizer: an element of fiscal policy that changes automatically as income changes.
9 Automatic Stabilizers Progressive TaxesAs income falls, the tax rate also falls, helping to maintain buying power and hence aggregate demandTransfer PaymentsExamples: Unemployment insurance, welfare, subsidiesInsure that buying power is not reduced at the same rate as income
10 Taxes: Some Definitions Direct taxes: on individuals and firms.Examples: income taxes and value-added taxes (VAT).Indirect taxes: on goods and servicesTax rate structures:progressive tax: rate increases with higher income.regressive tax: rate falls with higher income.proportional tax: rate is constant.
11 Central Government Spending by Functional Category
12 Supply-Side Economics and the Laffer Curve Taxes are a disincentive to productive activity.At marginal tax rates greater than t, the tax base shrinks at a faster rate than the increases in marginal tax rate.Net result: increases in marginal tax rates beyond t result in reduced tax revenues.