Fiscal Policy by yaofenji

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									Fiscal Policy
How the government uses
discretionary fiscal policy to influence
the economies performance
Discretionary Fiscal Policy
 The deliberate use of changes in government spending or
 taxes to alter aggregate demand

Examples of Expansionary Fiscal Policy
 • Increase government spending
 • Decrease taxes
 • increase government spending and taxes equally
Examples of Contractionary Fiscal Policy
 • Decrease government spending
 • Increase taxes
 • Decrease government spending and taxes equally
Government Fiscal Policy to Combat a Recession
                                    • Increase Government
Price                  AS             Spending
Level                               • Decrease Tax




 155

 150
                                       AD2
                              AD1


                 $6   $6.1         $6.2
                          full
                      employment    Real GDP
                      Increase in the
                      price level and
                       the real GDP

              Increase in the
                aggregate
              demand curve

Increase in
government
 spending
Spending Multiplier
 Any initial change in spending leads to a chain reaction of
 more spending which causes a greater change in demand

Calculating the Spending Multiplier
 The ratio of the change in real GDP to an initial change
 in aggregate expenditure

Marginal Propensity to Consume (MPC)
 The change in consumption resulting from a change in
 income
                              C
             MPC =
                              Y
Spending Multiplier
       1
    1 – MPC
   MPC = 0.75
       1
             =4
    1 – 0.75
Real GDP increases with an increase in
government spending of $50 billion
    M x ΔG = ΔQ
    4 x $50 billion = $200 billion
Tax Multiplier
 The change in aggregate demand (total spending) resulting
 from an initial change in taxes
 When government cuts taxes by $50 billion
  The multiplier process is less because initial spending
  increases only by $38 billion instead of $50 billion
  The tax cut has a smaller multiplier effect on aggregate
  demand than an equal increase in government spending
Tax Multiplier Formula
  1 – spending multiplier
 With spending multiplier of 4 the tax multiplier is
   1 – spending multiplier = -3

 Real GDP increases by $150 billion with a cut in
 taxes of $50 billion 3 x $50 billion = $150 billion
The MPC can change from one time
period to another
Fiscal policy be used to combat
inflation when the economy is
operating in the intermediate range of
the aggregate supply curve
  Fiscal Policy to Combat Inflation
                          • Reduce Government Spending
                          • Increase Tax
               AS


$160

$155                      AD1

                         AD2


       $6   $6.1                   Real GDP
                full
            employment
                        Decrease in the
                          price level


           Decrease in the
          aggregate demand
                curve


      Decrease in
government spending
 or increase in taxes
What happens to Aggregate Demand (AD)
with a cut in Government (G) spending of
25 billion?

 ΔG x GM = ΔAD        GM = Government Spending Multiplier

 -$25 billion x 4 = -$100 billion

What will happen to AD with a cut in
taxes of 33.3 billion?
 ΔT x TM = ΔAD         TM = Tax Multiplier

 $33.3 x -3 = -$100 billion
Balanced Budget Multiplier
 An equal change in government spending and taxes, will
 change aggregate demand by the amount of the change in
 government spending

Automatic Stabilizer
 Federal expenditures and tax revenues that automatically
 change levels in order to stabilize an economic expansion or
 contraction

Examples of Automatic Stabilizers
• Transfer payments
• Unemployment compensation
• Welfare
Budget Surplus
 A budget in which government revenues exceed
 government expenditures in a given time period
Budget Deficit
 A budget in which government expenditures exceed
 government revenues in a given time period
                                         Automatic Stabilizers
                                $1,250
Government Spending and Taxes


                                                                        T
                                $1,000


                                          Budget
                                          deficit
                                 $750

                                 $500

                                 $250                                   G

                                         $4 bil      $6 bil    $8 bil
                                                    Real GDP
                         Budget surplus
                         offsets inflation


              Tax collections rise and
               government transfer
                   payments fall


Increase in
 real GDP
                         Budget deficit
                       offsets recession



              Tax collections fall and
               government transfer
                  payments rise


Decrease in
 real GDP
Supply-side Fiscal Policy
A fiscal policy that emphasizes government policies that
increase aggregate supply
Purpose: to achieve long-run growth in real output, full
employment, and a lower price level
       Demand-Side Fiscal Policy

                                  AS
$250

$200

$150                              AD2

$100
                         AD1

         2   4      6         8        10   12
                     full
                 employment             Real GDP
   Increase in the aggregate
        demand curve



     Increase in
government spending;
decrease in net taxes
       Supply-Side Fiscal Policy

                              AS1
$250
                                         AS2
$200

$150

$100
                             AD

   0    2   4      6         8      10    12
                    full
                employment           Real GDP
 Increase in the aggregate
       supply curve



 Decrease in resource
 prices; technological
 advances; subsidies;
decrease in regulations
Supply-Side Policies Affect Labor Markets
   Wage rate
                        Before tax-cut   After tax-cut
                        labor supply     labor supply



 W1

 W2
                                          Labor
                                         Demand


                          L1       L2      Q of Labor
Tax rate cuts                        Supply-side
                                     policy
   Higher disposable income
  boosts worker’s incentives to
    work harder and produce
             more

               Firms invest more and
            create new ventures, which
             increase jobs and output

                     Aggregate supply
                      curve increase

                              Economy expands,
                             employment rises, and
                              inflation is reduced
Tax rate cuts                             Keynesian
                                          policy
    Higher disposable income
       increases money for
             spending


                People spend extra income
                on more goods and services


                       Aggregate demand
                         curve increase

                                 Economy expands,
                                employment rises, but
                                  inflation rate rises
Laffer Curve
 Puts forth the idea that increasing taxes from zero will
 increase tax revenues up to a certain point

Taxes increases may lead to higher
government revenues
 Depends on where the economy is on the Laffer Curve

When taxes increase beyond a certain
point tax revenues begin to decline as the economic pie
begins to shrink

Economic pie begins to shrink as Workers
have less incentive to work and investors have less of an
incentive to invest as their taxes increase beyond a
certain level
The Laffer Curve

      Rmax
Federal Tax Revenue




                      R




                      0   Tmax   T   100%
                                     Federal Tax Rate

								
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