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

2. Remember the graph?

3. Fiscal Policy

4. Tools of fiscal policy
Taxes
Government Spending

5. 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

6. 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

7. 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 )

8. 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

9. 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

10. 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 )

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

12. The economy is experiencing a recession
Expand

13. The economy is experiencing inflation
Contract

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

15. Inflation is at 27%
Contract

16. Contract

17. Expand

18. Are the following fiscal policies expansionary or contractionary?

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

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

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

22. 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

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

24. The Government cuts personal income tax rates.
Discretionary
Expansionary

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

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

27. The government raises corporate income tax rates.
Discretionary
Contractionary

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

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

30. 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

31. Suppose Government increases spending by $50 Billion
For Example
Suppose Government increases spending by $50 Billion
AD1 shifts right to AD2
MPC = 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

32. 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

33. 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

34. 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

35. 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

36. 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

37. 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

38. 1984 Walter Mondale Ronald Reagan

40. 1988

41. 370
168
1992