Presentation on theme: " Gov. can affect AD through G or T Directly: increase or decrease G, AD shifts Indirectly: increase or decrease T and C and I will change, which."— Presentation transcript:
Gov. can affect AD through G or T Directly: increase or decrease G, AD shifts Indirectly: increase or decrease T and C and I will change, which will shift AD
What’s the difference between actual and full employment? Draw an economy with a recessionary gap.
Expansionary Fiscal Policy When AD is too low, the economy is not at full employment (or potential GDP) Fiscal policy is expansionary to increase AD by increasing spending and/or reducing taxes moves the economy toward full employment
Expansionary policy increases employment, but can raise price level Result in budget deficits
Contractionary Policies If the level of AD is too high, it creates inflationary pressures. Fiscal policy is contractionary Reduce taxes and/or decrease spending Moves economy to full employment
Contractionary policies can reduce inflationary pressures, but Can reduce output Reduce employment level Can also result in budget surpluses ( or smaller deficits)
The multiplier effect Tax multiplier Always negative MPC/ (1-MPC) Same as MPC/MPS Any change in taxes has a greater effect on C and/or I
The multiplier effect The spending multiplier 1/(1-MPC) Same as 1/MPS Any change in government spending has a greater effect than the amount of the spending
Because of the multiplier effect the change in G or T to close a recessionary or inflationary gap (between the actual equilibrium level and the full employment level of output) will be smaller than the gap. Change in G or T multiplied by the multiplier should equal the size of the gap.
Discretionary Fiscal Policy When the government chooses to change G or T, at the discretion of Congress and the president.
Automatic Fiscal Policy Policies that work to stabilize the economy through changes that happen automatically. No one needs to make a decision about these; a system is already in place. Progressive income tax, unemployment, income based-transfer payments,
Any policy that changes a determinant of of SRAS will affect the macroeconomy through the supply side. What are the determinants of SRAS?
Determinants of SRAS ( things that will shift the SRAS): Economy wide input prices (like wages and energy prices) Productivity Factors that affect LRAS: Increase in available resources Higher quality resources Technological advances
Draw 2 correctly labeled AS/AD graphs. Show the effect of the following on eq. price and RGDP: Graph 1 increase in AD Graph 2 increase in AS What are the differences in the results for graph 1 and 2?
Goals of Monetary and Fiscal policy Economic growth Full employment Price stability
How might a shift in AS move the economy toward the main goals? What might cause such a shift?
AD 1 LRAS SRAS AD Price Level RGDP PL PL 1 Y* Y1Y1 Suppose the Fed increases the MS: Interest rates decrease Investment and interest sensitive consumption increases Increase in AD Output increases PL increases
AD 1 LRAS SRAS AD Price Level RGDP PL PL 1 Y* Y1Y1 New short run equilibrium has output above the full employment level. As a result, nominal wages will rise (the demand for more workers to increase output allows workers to bargain for higher wages.
AD 1 LRAS SRAS AD Price Level RGDP PL PL 1 Y* Y1Y1 The higher wages lead to a leftward shift of the AS. New long run- equilibrium at full- employment level Higher price level In the long run, increase in MS has NOT changed RGDP, only increase in PL. SRAS 1 PL 2