Remember Aggregate Demand and Aggregate Supply? This formula also works for AD

Remember the graph? https://www.youtube.com/watch?v=kzNo54d-ZoE&index=1&list=PLBC35DEA1D1A98034

Fiscal Policy https://www.youtube.com/watch?v=TY3JoxcyPAM

Tools of fiscal policy Taxes Government Spending

Expansionary Fiscal Policy A. Put in place to fix recessionary gap B. Goals 1. combat recession 2. stimulate the economy 3. increase AD 4. Shift AD curve to the right – close recessionary gap

II. Expansionary Fiscal Policy C. Tools 1. Increase government spending a. spending increase shifts AD to the right Reduce taxes a. Tax cut puts money in the hands of consumers b. Consumers spend additional money to shift AD curve to the right. D. May cause budget deficit

Expansionary Policy on the graph During a recession, short run equilibrium is below full employment level of output. AD is too low Government can increase AD by: Spending more (in the formula G ) Cutting taxes (which means you will spend more and in the formula C )

Contractionary Fiscal Policy A. Put in place to fix inflationary gap B. Goals 1. combat demand pull inflation 2. slow economics growth 3. decrease AD 4. Shift AD curve to the left– close inflationary gap

cut government spending a. spending cut shifts AD to the left III. Contractionary Fiscal Policy C. Tools cut government spending a. spending cut shifts AD to the left 2. increase taxes a. Tax increase takes money away from consumers b. Consumers spend less money shifting AD left D. May cause budget surplus

Contractionary Policy on the graph When there is inflation, short run equilibrium is above full employment level of output. AD is too high Government can decrease AD by: Spending less (in the formula G ) Raising taxes (which means you will spend less and in the formula C ) https://www.youtube.com/watch?v=9B-gIfhnyeo

Should we expand or contract? What kind of fiscal policy should be pursued in order to “fix” the economy? Should we expand or contract?

The economy is experiencing a recession Expand

The economy is experiencing inflation Contract

The latest economic statistics show an unemployment rate of 12% Expand

Inflation is at 27% Contract

Contract

Expand

Are the following fiscal policies expansionary or contractionary?

The Government cuts business taxes Expansionary –- The business tax cut increases investment spending

The Government increases spending Expansionary –- Increase in government spending increases aggregate demand

The Government increases the personal income tax. Contractionary – personal disposable income decreases because of the tax increases thus reducing consumption and investment spending.

IV. Discretionary and Automatic Stabilizers A. Discretionary 1. a specific action that has to be taken by government 2. passing a law to change taxes or spending B. Automatic stabilizers 1. policies or laws already in place 2. unemployment insurance – payments keep AD from falling as much as they would otherwise

Do the following scenarios represent automatic or discretionary stabilizers AND Is it an example of Expansionary contractionary policy

The Government cuts personal income tax rates. Discretionary Expansionary

Incomes rise; as a result, people pay a larger fraction of their income in taxes. Automatic Contractionary

As a result of a recession, more families qualify for food stamps and welfare benefits. Automatic Expansionary

The government raises corporate income tax rates. Discretionary Contractionary

The government launches a major new space program to explore Mars. Discretionary Expansionary

Corporate profits increase; as a result, government collects more corporate income taxes. Automatic Contractionary

Fiscal Policy and the Multiplier A. Government Purchases 1. AD will initially shift by the amount of the government purchase 2. AD will shift a second time because of the multiplier a. Government spending means rising income for consumers b. Consumers will spend their raises – which increases AD c. Amount of second shift will depend on the multiplier

Suppose Government increases spending by $50 Billion For Example Suppose Government increases spending by $50 Billion AD1 shifts right to AD2 MPC = .5 What is the multiplier? Multiplier = 2 Increase G = $50 billion $50 billion (G) x 2 (multiplier) = $100 total increase in real GDP AD shifts again from AD2 to AD3 Another $50 billion $50 billion

Fiscal Policy and the Multiplier A. Government Purchases B. Taxes 1. AD will initially shift a. Shift is less than full amount of tax change because of MPS

Consumers will only spend $25 billion Increase C = $25 billion NOW Suppose instead of spending the money themselves Government hands out $50 Billion in tax cuts Since MPC =.5 Consumers will only spend $25 billion Increase C = $25 billion $25 billion

Fiscal Policy and the Multiplier A. Government Purchases B. Taxes 1. AD will initially shift a. Shift is less than full amount of tax change because of MPS 2. AD will shift a second time a. Tax cut means rising income for consumers b. Consumer spending will increase raising AD further c. Amount of second shift will depend on the multiplier

Consumers will only spend $25 billion Increase C = $25 billion NOW Suppose instead of spending the money themselves Government hands out $50 Billion in tax cuts Since MPC =.5 Consumers will only spend $25 billion Increase C = $25 billion $25 billion (C) x 2 (multiplier) = $50 billion total increase in real GDP another$25 billion $25 billion

VI. Deficits can be financed by A. Borrowing 1. selling bonds 2. may cause crowding out B. Money creation 1. issue new money to creditors 2. may be inflationary VII. Surplus money can be used for: A. Debt reduction 1. done by buying back bonds 2. puts money into the money supply – may create inflation B. Impounding 1. allow the surplus to just stand idle 2. government withholds purchasing power

VIII. The Political Business Cycle A. Fiscal policy happens in the political arena and is handled by politicians B. Election results are determined by the economy C. Economic policy can be used to serve political ends. D. Monetary policy in the hands of the Fed can be a solution

1984 Walter Mondale Ronald Reagan https://www.youtube.com/watch?v=07m39CQRJXw

1988 https://www.youtube.com/watch?v=RZtaZTEO3jA

370 168 1992