2. FISCAL POLICY Even if I have to dig a hole and cover it back up, I do have a job.

3. The Demand for Loanable Funds Market aa a Interest Rate 3% 3% A Trillions of Dollars A 1.5 (a) (b) 3% 3% Demand for L oanable Funds at 3 % [no G borrowing] Business firms demand for L oanable Funds at 3 % [a lot of investment] D m[ no G] QID 1 QID 1 MS DIDIDIDI Money Market Low interest rates, so - a lot of investment Trillions of Dollars

4. The Demand for Loanable Funds Market aa a Trillions of Dollars Interest Rate 5% 3% A Government Demand for Funds B Trillions of Dollars A Business Demand for Funds 1.0 B 1.5 (a) (b) 5% 3% With “G” borrowing, the demand for LF at 5 % Business firms d emand for Loanable Funds at 5 % [not as much investment] DmDmDmDm D m (G) QID2 QID1 MS DiDiDiDi Money Market Higher interest rates, so not as much investment

5. B alanced B udget [$2 T ril. “G” = $2 T ril. “T”] $2 Trillion G T Recession Incr G to $2.2 or or Decr T to $1.8 Deficit so higher I.R. Inflation Decr G to $1.8 or Incr T to $2.2 Surplus so Lower I.R. Budget So expansionary fiscal policy leads to higher interest rates. Deficit Wow! A surplus So, contractionary fiscal policy leads to lower interest rates. Gonna have to borrow

6. Real GDP Q PL AS AD 2 YRYRYRYR YFYFYFYF Expansionary Fiscal Policy [Incr G; Decr T] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DICAD Y/Emp/PL; TLFMIR Start from a Balanced Budget G & T = $2 Trillion $ 2 T $2 T “I can’t get a job.” “N ow, this is better.” G T G T E1E1E1E1 E2E2E2E2 LRAS

7. Real GDP Q PL AS AD 2 YIYIYIYI YFYFYFYF Contractionary Fiscal Policy [Decr G; Incr T to close a contractionary gap ] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DICAD Y/Emp/PL; TLFMIR Start from a Balanced Budget G & T = $2 Trillion $2T $2T G T G T [like we have “money trees”] E1E1E1E1 E2E2E2E2

8. Expansionary Fiscal Policy Recessionary Gap T G Fiscal Policy During Recession SRAS AD2 AD2 Y R Y * AD1 Keynes and Lydia Lopokova

9. Expansionary Fiscal Policy Inflationary Gap T G Fiscal Policy During Inflation SRAS AD2 AD2 Y* YIY* YIY* YIY* YI AD1 Contractionary Fiscal Policy G T

10. Automatic Stabilizers automatic pilot The automatic stabilizers may be called the automatic pilot of our economy of our economy, not very well suited for takeoffs and landings, going gets but fine for the smooth part of the flight. But when the going gets roughmust use manual controlsdiscretionary G&T rough, the economy must use manual controls. [discretionary G&T] Automatic stabilizers take 33-50% out. S tabilizers are like a thermostat maintaining temperature. 33-50%

11. BUILT-IN STABILITY GDP 1 GDP 2 GDP 3 Real Domestic Output, GDP Government Expenditures, G, and Tax Revenues, T Deficit Surplus Taxes G YRYRYRYRY* YiYiYiYi More vertical [progressive], the more stability for the economy. Transfers Surplus FewerTransfers MoreTransfers Less Tax Money

12. Discretionary Fiscal Policy Deliberate use of government spending and/or taxing. “G” and “T” Nondiscretionary Fiscal Policy Automatic Stabilizers 1.Welfare & food stamps 2. Unemployment insurance 3. Social security 4. Corporate Dividends Progressive Tax System 5. Progressive Tax System Unempl. check Discretion of Congress

13. Suppose the economy is in recession: Real GDP Taxcollections Transfer payments GT G > T The deficit grows Fiscal Policy Automatic stabilizers. AS AD 2 AD 1 “Recession” Y R Y* PL

14. If the economy has an inflationary gap: Taxcollections Transfer payments G TG < TG TG < T The surplus grows Fiscal Policy Automatic stabilizers. Real GDP AS “Inflationary Gap” AD 2 AD 1 Y* Y I PL

15. Discretionary Fiscal Policy Discretionary Contractionary Fiscal Policy 1.Decrease “G” 2.Increase “T” Expansionary Fis. Policy 1.Increase “G” 2.Decrease “T”

16. The Kennedy/Johnson $10 Bil. Tax Cuts of 1964 The “Golden Age of Fiscal Policy”

17. When Kennedy came into office: 91 % 1.The top marginal tax rate was 91 % drops to 52% and drops to 52% compared 35% to 35% today. 6.7 % 2. The unemployment rate was 6.7 % below 5% and drops below 5%. recession low unemployment- low inflation (2%) economy 3. A recession becomes a very good low unemployment- low inflation (2%) economy expansion 4. The expansion continued to 1969. Fiscal Policy and Tax Cuts Fiscal Policy and Tax Cuts.

18. YR

19. Keynesian Policy: “ Balance the Economy, not the Budget.” DeficitsSurpluses “Even if the jobs are digging holes and filling them up.”

20. FINANCING OF DEFICITS [Should we borrow or just print the money?] 1. Borrowing from the public [results in higher interest rates which crowds out investment] which crowds out investment] 7%4% 7%4% MS1 MS2 D M2(g) D M1 AS AD 2 Y * Y Y * Y 2. Just print the money [Money creation – lower interest rates [Money creation – lower interest rates so this would be more expansionary] so this would be more expansionary] But the LR increase in MS results in an increase in inflation PL 1 PL 2 AD 1

21. How To Dispose of Surpluses [Should we hold the surplus or give it back] 1. Debt Retirement [give the surplus back during recessions to get lower interest rates and expand the economy] AS AD 2 Y* Y I 2. Impound The Surplus [keep the surplus during inflations and give it back during recessions] PL AD 1

22. IDIDIDID Investment (billions of dollars) Real interest rate (%) THE “CROWDING OUT” EFFECT [Incr G incr I.R. Decr Ig] 16 14 12 10 8 6 4 2 0 15 5 10 15 20 25 30 35 40 CrowdingOutEffect AS AD 1 AD2 4%2%4%2% YRYRYRYR G IGIGIGIG G can finance a deficit by: 1. Borrowing - this raises interest rates and “crowds out” investment. “crowds out” investment. 2. Money Creation - no “crowding out” so is more expansionary than borrowing. more expansionary than borrowing. Friedman Just follow the “monetary rule.”

23. Y R Y * Y* Y i Negative Net Export Effect of Fiscal Policy Y R Y* Due to lower interest rates, dollar deprec. E xpansionary Fiscal Policy “Negative Xn” C ontractionary Fiscal Policy Due to higher interest rates, dollar apprec.

24. Liberal (“ G ”) or Conservative (“G”) Liberals Recession: Increase “G”; Inflation: Increase T “ G G Conservatives Recession: Decrease “T”; Inflation: Decrease “G”

25. Fiscal Policy Lags starts out too cold “The shower starts out too cold, because the pipes have turns up the hot water not yet warmed up. So the fool turns up the hot water. turns up the hot water further nothing happens, so he turns up the hot water further. scalds himturns up the The hot water comes on and scalds him. He turns up the cold waterturns up cold water. Nothing happens right away, so he turns up the cold further the cold further. When the cold finally starts to come up, too cold he finds the shower too cold, and so it goes.” Fiscal Policy lags 1.Data (recognition) lag 2.“Wait-and-see” lag – short run 3.Legislative lag (political) 4.Effect lag [takes months]

26. The G is like a “ Fool in the Shower.” YFYFYFYF YRYRYRYR YIYIYIYI AD 2 AD 1 LRAS LRAS SRAS 1 SRAS 2 E4E4E4E4 E4E4E4E4 E2E2E2E2 E1E1E1E1 E2E2E2E2 E3E3E3E3

27. Traditional Fiscal Policy [“G” & “T”] will not work with Stagflation AD 1 LRAS 4% 5%5%5%5% 10 % 10 % 10 % Y R SRAS 2 Stagflation AD 2 15% 15 % AD3 YFYFYFYF YRYRYRYR

28. Laffer Curve and Supply-Side Economics “closet Keynesian” Was Reagan a “closet Keynesian” with all the “G” & “T”? “Keynesian in drag.” Perhaps he was a “Keynesian in drag.”

29. 0 100 l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

30. 0 100 m l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

31. 0 100 m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

32. 0 100 m m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent) Maximum Tax Revenue

33. SUPPLY-SIDE FISCAL POLICY Emphasis on Expansionary Tax Cuts [ which shifts AD to the right, increasing Y & PL] Impact upon... Saving and Investment [Lower taxes increase DI & S; less business taxes will increase investment. Our “national factory” will increase.] Work Incentives [Keeping more of our money makes us work harder and longer] Risk Taking [Lower tax rates promise a larger potential after-tax reward] AS Curve will shift right bringing prices down. So, the AS Curve will shift right bringing prices down.

34. SUPPLY-SIDE FISCAL POLICY 0 Price level Real domestic output, GDP AD 1 AD 2 AS 1 AS 2 P1P1 P2P2 P3P3 Q1Q1 Q2Q2 Q3Q3 Can sustain a much greater increase in AD if the AS curve is also shifting to the right.

35. LEGISLATIVE MANDATES Employment Act of 1946 C ouncil of E conomic A dvisors (CEA) J oint E conomic C ommittee (JEC)

36. Legislative Mandates for Remedial Fiscal Measures Employment Act of 1946 1. Employment Act of 1946 – a law promoting economic stability “maximum employment, production, and (by promoting “maximum employment, production, and purchasing power”monetary and fiscal policies purchasing power”) through monetary and fiscal policies. government commitment This act was a government commitment to ensure prosperity “could”“would” after WW II. [ not only “could” but “would” – no more laissez faire] Keynesians economists This act gave the Keynesians economists the theoretical and legal justificationuse fiscal policy legal justification to use fiscal policy to stabilize the economy. Council of Economic Advisers (CEA) 2. Council of Economic Advisers (CEA) President3 distinguished economists [for the President] – 3 distinguished economists ( on leave from assist & advise the President universities) who assist & advise the President on economic matters. Their staff is made up of 11 senior and 6 junior economists. deficit, inflation, GDP growth, They forecast & project the deficit, inflation, GDP growth, foreign exchange rates, immigration, & antitrust legislation foreign exchange rates, immigration, & antitrust legislation. The President must submit an annual economic report describing the current economic state with recommendations. “T he President’s intelligence arm in the war against the business cycle.”

37. Head of the CEA Greg Mankiw of Harvard has ridiculed supply-side tax cuts as “fad economics” conceived by “ charlatans and cranks,” in his textbook. Harvey S. Rosen of Princeton has succeeded Mankiw.

38. Joint Economic Committee of Congress and Humphrey-Hawkins Act of 1978

39. Keynesians Return To Washington [1993] Nobel Prize in Economics-2001

40. ADDING THE PUBLIC SECTOR[“ ”] Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 390 470 550 C C + I g + X n C + I g + X n + G Government Spending of $20 Billion $20 Billion Government Purchases and Equilibrium GDP S Mixed - open $ 20 bil. for Nat. Defense “M” = 4

41. $15 B decrease in “C” [ & $60 B total decrease in Y from a $20 billion in Y from a $20 billion increase in taxes increase in taxes ADDING THE PUBLIC SECTOR[“ ”] Incr. T by $20 bil.[ MT = 3] Equilibrium GDP[-60] Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 550 C + I g + X n + G C a + I g + X n + G 490 S Mixed-Open $20 bil. increase in “T”

42. $490 bil.

43. Employment Act of 1946 1. With the Employment Act of 1946, the federal government committed itself to accept (total/some) degree of responsibility for employment/prices. Fiscal policy 2. Fiscal policy is carried out primarily by the (local/state/federal ) government. Discretionary fiscal policy 3. Discretionary fiscal policy [G & T] (does/does not) require congressional action. mixedclosed economy 4. In a mixed [private & public) closed economy, taxes & (savings/government spending) leakages injections are leakages, while Ig and (savings/government spending) are injections. 5. In a mixed economy, the equilibrium GDP exists where (C+Ig/C+Ig+G+Xn) = GDP. balanced budget multiplier 6. The balanced budget multiplier indicates that equal increases in G&T tend to (decrease/increase/not change) the equilibrium GDP. [M BB is “1”] equilibrium GDP is $400 billion 7. Assume in a private economy that equilibrium GDP is $400 billion & the MPC is G collects new taxes of $50 bil.spends the entire amount.80. Suppose the G collects new taxes of $50 bil. & spends the entire amount on our infrastructure. As a result equilibrium GDP will be ($400/$450/$500) bil. constitutional amendmentG always balance 8. Suppose a constitutional amendment requires that the G always balance its budgetincrease GDP by $40 billion its budget. If it desired to increase GDP by $40 billion, G should (increase/decrease) government spending & taxes by ($30/$40/$50) billion. Fiscal Policy NS 1-8

44. Y CA

45. during a recession 14. If G increases its spending during a recession to assist the economy, the funds must come from some source. (Additional taxes/Borrowing from the public/Creating new money) most expansionary would tend to be the most expansionary. fiscal actions 15. The following fiscal actions, ( incurring a budget surplus and allowing it to accumulate as idle Treasury balances/ incurring a budget surplus which is used to retire debt held curbing inflation by the public) is likely to be most effective in curbing inflation. greatest anti-inflationary impact of a budget 16. The greatest anti-inflationary impact of a budget surplus surplus will occur when the G (impounds/uses) the surplus funds & lets them (stand idle/pay off the debt). built-in stabilizers 17. In describing the built-in stabilizers, we can say that personal & corporate income tax collections as GDP increasestransfers automatically (incr/decr) as GDP increases and transfers & subsidiesas GDP increases & subsidies (incr/decr) as GDP increases. Should I give it back?

46. Recognition, Action, & Effect Lags of Fiscal Policy Action Lag

47. Political Business Cycles? Political Business Cycles:Politicians manipulate fiscal policy to get voter support.No politician wants to go into the next election known as the “tax-raising, project-cancelling boom killer.” These policies can lead to “Made in Washington” recessions after the election to slow down the inflationary economy. The economy can be corrected prior to the next election. “The economy is largely a toy to be pulled this way and that for political purposes.” 0 Y P Real GDP Presidential Elections and U.S. Recessions, 1948-2002 Election Winner Next Recession Election winner Next Recession Nov, 48 Truman Nov. 48-Oct. 49 Nov. 72 Nixon Dec. 73-Mar. 75 Nov. 52 Ike June, 53-May 45 Nov. 76 Carter Jan. 80-July 80 Nov. 56 Ike June, 57-Apr. 58 Nov. 80 Reagan May 81-Nov. 82 Nov. 60 Kennedy Apr. 60-Feb. 61 Nov. 84 Reagan Incr bor. by $2 tr. Nov. 64 Johnson Viet Nam War Nov. 88 Bush 41 July 90-Mar. 91 Nov. 68 Nixon Oct. 69-Nov. 70 Nov. 92 Clinton None Nov. 01 Bush 43 Jan. 01-Sept. 01 “Voters tend to remember the last one or two years prior to an election.” *Tell them what they want to hear.

48. FISCAL POLICY – Pure and Simple Fiscal Policy: No Complications Price level Real GDP (billions) AD 1 AD 2 P1P1 $490 YR YR AS “diminish AD.” There are 2 things that could “diminish AD.” $510Y*

49. Fiscal Policy: Showing Crowding-out Effect or Net Export Effect Price level Real GDP (billions) AD 1 AD 2 P1P1 $490$510 $490 $510 AS AD’ 2 $504 “diminish AD.” There are 2 things that could “diminish AD.” [Crowding-out and net export effect]

50. FISCAL POLICY AND INFLATION Price level Real GDP (billions ) AS AD 2 $ 495$515 P1P1 AD 1 $505

51. Answer the next 3 questions(18-21) based on the diagram. Deficits 18. Deficits will be realized at GDP levels (below/above) C, and surpluses (below/above) C. D 19. If the F.E. GDP for the economy is at D, the F.E. budget will entail a (deficit/surplus). tax line had a greater slope 20. If the tax line had a greater slope [more progressive tax system], stability stability would be (less/greater). adhered strictly to an annually balanced budget 21. If government adhered strictly to an annually balanced budget then the government’s budget would tend to (destabilize/stabilize) the economy. T2T2 NS 18-21 D A B C

52. NS 22-30 For Questions 22-24 22. (T1/T4) tax system is characterized least built-in stability by the least built-in stability. 23. (T1/T4) tax system is characterized by the most built-in stability. 24. (T1/T4) tax system will generate the largest cyclical deficits largest cyclical deficits. Nondiscretionary 25. Nondiscretionary Fiscal Policy (does/does not) require congressional action. $10 B increase in “G”increase “C” 26. If the MPC is.5, a $10 B increase in “G” will increase “C” not income [not income] by ($20/$10/$5) billion. [G increase in spending of $10 B increases income (Y) by $20 B. With MPC of.5, C increases $10 B] 27. If government tries to give back a surplus during an inflationary FE year, this will be (pro-cyclical/counter-cyclical). improvement 28. When politicians use fiscal policy to cause an improvement in the economy just prior to an election in the economy just prior to an election, this is called a (presidential/Congressional/political) business cycle. G incurs a deficit which is financed by borrowing 29. When G incurs a deficit which is financed by borrowing, interest rates to increase which decreases Ig causing interest rates to increase which decreases Ig, this is called the (crowding-in/crowding out) effect. Supply-sidersprimary effect of tax cuts 30. Supply-siders argue that the primary effect of tax cuts is to shift the AS curve (leftward/rightward).

53. NS 31-34 C+Ig+G(AE)

54. NS 35 - 38 If G decreases G and T by $10 billion, G increases G & T by $8 billion. -6 36. 37. 38.

55. Expansionary fiscal policy 1. Expansionary fiscal policy will be most effective [increase GDP] when the AS curve is (vertical/horizontal) & (incr/decr) “C” and (incr/decr) unemployment. paradox of thrift 2. The paradox of thrift indicates that an increase in saving (matched/ unmatched) by an increase in investment will lower equilibrium GDP. contractionary fiscal policydecr G, incr T 3. A contractionary fiscal policy [decr G, incr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. expansionary fiscal policyincr G, decr T An expansionary fiscal policy [incr G, decr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. AE[AD]doesn’t buy up FE output(GDP) 4. In the AE model, if AE[AD]doesn’t buy up FE output(GDP), then the equilibrium output is (less than/more then) full employment output. Fiscal Policy Test Review 1-4 [G ; LFM ; In. Rates ] G $2 Tr. T $2 Tr. [On #3, start from a balanced budget] “Recessionary Gap” “Inflationary Gap”

56. decrease AD the greatest amount 5. To decrease AD the greatest amount, the government should: (decrease “G” only/increase “T” only/both decr G & incr T) 6. To increase AD the greatest amount, the “G” should: (increase “G” only/ increase “T” only/both incr G and decr T) recessionary gap equilibrium point[actual GDP] 7. In a recessionary gap (AE model) at the equilibrium point[actual GDP] planned investmentsaving,FE planned investment is (greater than/equal to/less than) saving, but at the FE GDP levelsaving GDP level, planned investment [backup ] is (greater than/equal to/less than ) saving. inflationarygap 8. In an inflationary gap(AE model), at the equilibrium point [actual GDP] planned investment [backup] is (greater than/equal to/less than) saving, but at the FE level, planned investment is (greater than/equal to/less than) saving. unplanned increase in inventories 9. If businesses are experiencing an unplanned increase in inventories, AE is FE output & spending (less than/greater than) FE output & spending will (increase/decrease). unplanned decrease in inventoresdisinvestment 10. If businesses are experiencing an unplanned decrease in inventores [disinvestment] FE output & spending AE is (less than/greater than) FE output & spending will (increase/decrease)

57. “C” equals income at $500 billionMPC is.9 11. If “C” equals income at $500 billion, & MPC is.9, then an increase in Ig of $10 billion will change equilibrium GDP to ($400/$490/$510/$600) billion. conservative economist 12. A conservative economist would want tax (incr/decr) during recessioninflationary times a recession & (incr/decr) in “G” during inflationary times. liberal economist 13. A liberal economist would want tax (incr/decr) during an inflationrecessionary periods inflation & (incr/decr) in “G” during recessionary periods. inflationary gap 14. An inflationary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. recessionary gap 15. A recessionary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. increase GDP[but reduce military spending] 16. To increase GDP[but reduce military spending], we would combine two (domestic/overseas) bases into one (domestic/overseas) base. tax cut to expand the economy 17. A tax cut to expand the economy would (incr/decr) Y & (incr/decr) in. rates. tax increase to contract the economy 18. A tax increase to contract the economy would (incr/decr) Y & (incr/decr) IR. 500 500

58. increase equilibrium GDP by $400,000 19.To increase equilibrium GDP by $400,000, with a MPC of.5, a Keynesian economist would ( decrease “T” /increase “G” ) by $ 200,000. equilibrium GDP is $500 billion 20. Assume equilibrium GDP is $500 billion & MPS is.4. “G” collects taxes of of $22 billion and spends Now “G” collects taxes of of $22 billion and spends the entire amount the entire amount. As a result, equilibrium GDP will change to: ($445/$478/$522/$555). MPC of.5$12 billion 21. With a MPC of.5, a $12 billion increase increase “C” in “G” will increase “C” by ($12/$24/$36) bil. MPC of.5 22. With a MPC of.5 and the economy in a recessionary spending gap of $12 billion recessionary spending gap of $12 billion, we may conclude that the equilibrium is short of FE GDP ($12/$24/$36) billion short of FE GDP. Test Review 19-22

59. Test Review – AE & Fiscal Policy increase in Ig of $25B 23. An increase in Ig of $25B results in an increase in equilibrium income(GDP) of $50B, so the MPS is? contractionary fiscal policy 24. A contractionary fiscal policy results in a(n) (incr/decr) in output, and a(n) (incr/decr) in interest rates. Increasing T &/or decreasing G 25. Increasing T &/or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment..5inflationary GDP G ap inflationaryGDP G ap reducing government spending 26. With a MPC of.5, and the economy with an inflationary GDP G ap of $ 50 B, G could eliminate this inflationary GDP G ap by reducing government spending by?.5current output at $500 bil. but FE output is $700 bil 27. With a MPC of.5 & current output at $500 bil. but FE output is $700 bil., correct fiscal policy would be to (increase G/decrease T) by $100 billion..5 $25 bil. [Incr T or Decr G]

60. Test Review – AE & Fiscal Policy increase in Ig 28. An increase in Ig in an economy (incr)/decr) GDP & (incr/decr) C. recessionary economy at FE GDP 29. I n a recessionary economy, at FE GDP, saving saving is (less than/more than) Ig. recessionary economy 30. In a recessionary economy, (actual Y/ potential Y) exceeds (actual Y/potential Y). mixed-closed economyno Xnleakages 31. I n a mixed-closed economy (no Xn), the leakages are? injections and the injections are? inflationary Gapat FE GDP 32. If the economy has an inflationary Gap, at FE GDP, saving saving (exceeds/is less than) planned investment. equal increase in G & T of $25 bil 33. If there is an equal increase in G & T of $25 bil., then outputinterest rates [based on PL] output will (incr/decr) & interest rates [based on PL] will (incr/decr). [S & T] [G & Ig]

61. The End E-conE-con

62. Review for AE and Fiscal Policy

63. The M E, M T, & M BB Multipliers M E[G, Ig, or Xn] = 1/MPS = 1/.25 = 4 increase So, G increase of $20 bil. will incr Y by $80 bil. [$20x4=$80] decrease And a G decrease of $20 bil. will decrease Y by $80 bil. [ - $20x4= - $80 bil.] M T = MPC/MPS =. 75/.25 = 3 decrease So, T decrease of $20 bil. will incr Y by $60 bil. [$20 x 3=$60] increase And a T increase of $20 bil. will decr Y by $60 bil. [ - $20x3= - $60] M BB = 1 increase So, an increase in G&T of $20 bil. will incr Y by $20 bil. [$20x1= $20 ] decrease A nd a decrease in G&T of $20 bil. will decr Y by $20 bil.[ - $20x1= - $20] increase in expendituresincrease GDP Any increase in expenditures x the M will increase GDP. decrease in expendituresdecrease GDP Any decrease in expenditures x the M will decrease GDP.

64. AE [ C + Ig ] AE [ C + Ig ] (billions of dollars) o 45 o C onsumption C + I g I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 390470 370 390 410 430 450 470 490 510 530 550 Equilibrium GDP after $20 bil. Ig [MPC=.75] AE[C+Ig] [“Basic” or “Simple” economy] C =$450 Billion $530 510 490470 450 430 410390 370 + 20 Ig +80 S Private Closed

65. AE [C+Ig] AE [C+Ig] (billions of dollars) o 45 o C onsumption C + Ig+Xn I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 390470 370 390 410 430 450 470 490 510 530 550 (C [450] + I g[20] +M [10] + X [10] = GDP) Equilibrium GDP after X of $10 & M of $10 C = $450 Billion $530 510 490470 450 430 410390 370 S Private Open

66. ADDING THE PUBLIC SECTOR [“ ”] Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 390 470 550 Consumption C + I g + X n C + I g + X n + G Government Spending of $20 Billion $20 Billion Government Purchases and Equilibrium GDP S Mixed - Open Private-public - ROW $20 bil. on N ational D efense

67. $20 bil. incr in T [-$20 x 3 = -$60] ADDING THE PUBLIC SECTOR[“ ”] Incr. T by $20 bil.[ M T = 3 ] Equilibrium GDP[-60] Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 550 C + I g + X n + G C a + I g + X n + G 490 S Mixed-Open Private–public-ROW $20 billion

68. B alanced B udget [$2 T ril. “G”=$2 T ril. “T”] $2 Trillion G T Recession Incr G to $2.2 or or Decr T to $1.8 Deficit so higher I.R. Inflation Decr G to $1.8 or Incr T to $2.2 Surplus so Lower I.R. Budget So expansionary fiscal policy leads to higher interest rates. Deficit Wow! A surplus So, contractionary fiscal policy leads to lower interest rates. Gonna have to borrow

69. Test Review – AE & Fiscal Policy increase in Ig of $75B $300B 1. An increase in Ig of $75B results in an increase in equilibrium income(GDP) of $300B, so the MPS is? expansionary fiscal policy 2. An expansionary fiscal policy results in a(n) (incr/decr) in output, and a(n) (incr/decr) in interest rates. Increasing T &/or decreasing G 3. Increasing T &/or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment..75inflationary GDP G ap $80B positive equilibrium GDP G ap reducing government spending 4. With a MPC of.75, and the economy with an inflationary GDP G ap of $80B, G could eliminate this positive equilibrium GDP G ap by reducing government spending by?.60current output at $650 bil. but FE output is $700 bil 5. With a MPC of.60 & current output at $650 bil. but FE output is $700 bil., correct fiscal policy would be to (increase G/decrease T) by $20 billion..25 $20 bil. [Decr T or Incr G] $2 Tr. G T

70. Test Review – AE & Fiscal Policy increase in Ig 6. An increase in Ig in an economy will (incr)/decr) GDP and (incr/decr) C. recessionary economy at FE GDP 7. I n a recessionary economy, at FE GDP, saving is (less than/more than) Ig. inflationary economy 8. In an inflationary economy, (actual Y/ potential Y) exceeds (actual Y/potential Y). complex economy C+Ig+G+Igleakages 9. I n the complex economy (C+Ig+G+Ig), the leakages are? injections and the injections are? inflationary Gapat FE GDP 10. If the economy has an inflationary Gap, at FE GDP, saving (exceeds/is less than) planned investment. equal increase in G&T of $10 bil 11. If there is an equal increase in G&T of $10 bil., then output will (incr/decr) & interest rates will (incr/decr). [S, T, & M] [G, Ig, X]

71. “OT”consumption 1. At income level “OT”, the volume of consumption is _____. “OT”saving 2. At income level “OT”, the volume of saving is _____. “APC” 3. The “APC” is equal to “1” at income level _____. Ig1“equilibrium GDP” 4. If Ig is Ig1, then “equilibrium GDP” is _____. Ig2“equilibrium GDP” 5. If Ig is Ig2, then “equilibrium GDP” is _____. Ig1Ig2equilibrium GDP 6. If Ig increases from Ig1 to Ig2, equilibrium GDP increases by _____. Ig1Ig2“MPC” 7. If Ig increases from Ig1 to Ig2, the “MPC” is equal to __________. OVOU“MPS” 8. As we move from income level OV to OU, the “MPS” is ________. “dissaving” 9. The economy is “dissaving” at income level _____. Consumption will be equal to income 10. Consumption will be equal to income at income level _____. TC CF OV OU OT UT BC/UT AE / VU OW OV W V U T B A 0 AE (C+Ig) AE (C+Ig2) AE (C+Ig1) Consumption F E D C Real GDP [Revised]