Fiscal Policy: The Basics 12-1. How big is the Government? To see how big of a role the government plays in the economy we need to see what percentage.

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Presentation transcript:

Fiscal Policy: The Basics 12-1

How big is the Government? To see how big of a role the government plays in the economy we need to see what percentage of the GDP is represented by the government sector United States Government plays a smaller role compared to other countries But it still plays a big role!

Fiscal Policy: The Basics

Remember the Flow! In Chapter 7 we saw the Circular-flow with Government Funds flow into the government in the form of : –Taxes –Borrowing Funds flow out: –Spending (purchases) –Transfer payment

An Expanded Circular-Flow Diagram: The Flows of Money Through the Economy

Sources of Tax Revenue in the United States, 2004

Government Spending in the United States, 2004 Social insurance programs are government programs intended to protect families against economic hardship.

The Government Budget and Total Spending Fiscal policy is the use of taxes, government transfers, or government purchases of goods and services to shift the aggregate demand curve.Fiscal policy is the use of taxes, government transfers, or government purchases of goods and services to shift the aggregate demand curve.

Change a Variable Change a variable Shift the Curve

Government Budget & Total Spending directlyGovernment directly controls one of the variables in GDP GDP = C + I + + X - IM G

Consumer Spending and Taxes Taxes affect Consumer spending Disposable Income = Total Income + Transfer payment - Taxes ConsumptionA fall in the Disposable Income leads to a fall in Consumption ConsumptioAn Increase in the Disposable Income leads to an increase in Consumption

Why? Why would the government want to shift the Aggregate demand curve?

Expansionary Fiscal Policy Expansionary Fiscal Policy Can Close a Recessionary Gap Expansionary fiscal policy increases aggregate demand. Recessionary gap

Why? Why would the government want to shift the Aggregate demand curve inward and shrink everyone’s income?

Contractionary Fiscal Policy Contractionary Fiscal Policy Can Eliminate an Inflationary Gap Contractionary fiscal policy decreases aggregate demand. Inflationary gap

Lags in Fiscal Policy In the case of fiscal policy, there is an important reason for caution: there are significant lags in its use. Realize the recessionary/inflationary gap by collecting and analyzing economic data  takes time Government develops an action plan takes time Implementation of the action plan  takes time