1. Unit 3: Aggregate Demand and Supply and Fiscal Policy1

2. Draw and Practice
Congress uses discretionary fiscal policy to the manipulate the following economy (MPC = .9)
LRAS
What type of gap?
Contractionary or Expansionary needed?
What are two options to fix the gap?
How much needed to close gap? AS P2
Price level
AD1 AD
-$5 Billion
$50FE $100
Real GDP (billions) 3

3. Draw and Practice
Congress uses discretionary fiscal policy to the manipulate the following economy (MPC = .8)
LRAS
What type of gap?
Contractionary or Expansionary needed?
What are two options to fix the gap?
How much initial government spending is needed to close gap? AS
Price level P1
AD2
AD1
+$40 Billion
$ $1000FE
Real GDP (billions) 4

4. Problems With Fiscal Policy5

5. Problems With Fiscal Policy
When there is a recessionary gap what two options does Congress have to fix it?
What’s wrong with combining both?
Deficit Spending!!!!
A Budget Deficit is when the government’s expenditures exceeds its revenue.
The National Debt is the accumulation of all the budget deficits over time.
If the Government increases spending without increasing taxes they will increase the annual deficit and the national debt.
Most economists agree that budget deficits are a necessary evil because forcing a balanced budget would not allow Congress to stimulate the economy.

6. Objective for aggregate demand Action on Taxes
Action on government spending
Effect on Federal Budget
Effect on the National Debt
National unemployment rate rises to 12 percent
Inflation is strong at a rate of 14% per year
Surveys show consumer are losing confidence in the economy, retail sales are weak and business inventories are increasing rapidly
Business sales and investment are expanding rapidly, and economists think strong inflation lies ahead.
Inflation persists while unemployment stays high.

7. Paul Solomon Video: Deficit and Debt
US Debt Clock

8. Explain this cartoon
2003

9. Who ultimately pays for excessive government spending?

10. Video: Government Stages Coup11

11. 12

12. 13

13. Additional Problems with Fiscal Policy
Problems of Timing
Recognition Lag- Congress must react to economic indicators before it’s too late
Administrative Lag- Congress takes time to pass legislation
Operational Lag- Spending/planning takes time to organize and execute ( changing taxing is quicker)
Politically Motivated Policies
Politicians may use economically inappropriate policies to get reelected.
Ex: A senator promises more welfare and public works programs when there is already an inflationary gap.

14. Additional Problems with Fiscal Policy
3. Crowding-Out Effect
In basketball, what is “Boxing Out”?
Government spending might cause unintended effects that weaken the impact of the policy.
Example:
We have a recessionary gap
Government creates new public library. (AD increases)
Now but consumer spend less on books (AD decreases)
Another Example:
The government increases spending but must borrow the money (AD increases)
This increases the price for money (the interest rate).
Interest rates rise so Investment to fall. (AD decrease)
The government “crowds out” consumers and/or investors

15. Additional Problems with Fiscal Policy
4. Net Export Effect
International trade reduces the effectiveness of fiscal policies.
Example:
We have a recessionary gap so the government spends to increase AD.
The increase in AD causes an increase in price level and interest rates.
U.S. goods are now more expensive and the US dollar appreciates…
Foreign countries buy less. (Exports fall)
Net Exports (Exports-Imports) falls, decreasing AD.

16. Explain this cartoon 17

17. Activity 18

18. Congressional Committees
As a group, analyze the situation, identify the problem, and identify your solution
The Good, the Bad, and the Ugly
Unemployment
Inflation
GDP Growth
Good
6% or less
1%-4%
2.5%-5%
Worry
6.5%-8%
5%-8%
1%-2%
Bad
8.5 % or more
9% or more
.5% or less

19. 1.) 1933 Situation: GDP fell -1.2% Inflation rate= -.5%
Unemployment Rate=25%
Your Solution:

20. 2.) 1944 Situation: GDP grew 8% Inflation rate= 3.7%
Unemployment Rate=1.2%
Your Solution:

21. 3.) 1980 Situation: GDP fell -0.3% Inflation rate= 13.5%
Unemployment Rate=7.1%
Your Solution:

22. 4.) 2003 Situation: GDP fell 0.5% Inflation rate= 1.5%
Unemployment Rate=12.0%
Your Solution:

23. 1.) 1933 Situation: GDP fell -1.2% Inflation rate= -.5%
Unemployment Rate=25%
Your Solution:
What actually happened:
FDR increased public works via the New Deal programs.

24. 2.) 1944 Situation: GDP grew 8% Inflation rate= 3.7%
Unemployment Rate=1.2%
Your Solution:
What actually happened:
War ended the next year and government orders for war materials decreased.
Many public works programs were discontinued

25. 3.) 1980 Situation: GDP fell -0.3% Inflation rate= 13.5%
Unemployment Rate=7.1%
Your Solution:
What actually happened:
The next year, President Regan and congress lowered taxes on individuals and corporations by about 30%. (Supply-side Economics)

26. 4.) 2003 Situation: GDP fell 0.5% Inflation rate= 1.5%
Unemployment Rate=12.0%
Your Solution:
What actually happened:
Congress voted to give tax cuts to citizens. (Bush Tax Cuts)