Module Economic Policy and the Aggregate Demand- Aggregate Supply Model odel KRUGMAN'S MACROECONOMICS for AP* 20 Margaret Ray and David Anderson.

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20 Module Economic Policy and the Aggregate Demand-Aggregate Supply Model odel KRUGMAN'S MACROECONOMICS for AP* Margaret Ray and David Anderson.

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20 Module Economic Policy and the Aggregate Demand-Aggregate Supply Model odel KRUGMAN'S MACROECONOMICS for AP* Margaret Ray and David Anderson.

Economic Policy and the Aggregate Demand-Aggregate Supply Model odel

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Module Economic Policy and the Aggregate Demand- Aggregate Supply Model odel KRUGMAN'S MACROECONOMICS for AP* 20 Margaret Ray and David Anderson

What you will learn in this Module : How the AD-AS model is used to formulate macroeconomic policy The rationale for stabilization policy Why fiscal policy is an important tool for managing economic fluctuations Which policies constitute expansionary fiscal policy and which constitute contractionary fiscal policy

Self-correction? Stabilization Policy Macroeconomic Policy John Maynard Keynes “Keynesian Economics” Can the market fix itself or does it need help from government?

Policy in the Face of Demand Shocks Negative Demand Shocks & Positive Demand Shocks Why are they bad? Should policymakers counteract?

Responding to Supply Shocks Supply shock Policy dilemma

Fiscal Policy: The Basics 2008

Taxes, Government Purchases of Goods and Services, Transfers, and Borrowing 2008

2008

The Government Budget and Total Spending GDP = C + I + G + X - M The effect of taxes and transfers Effects on Investment

Expansionary and Contractionary Fiscal Policy Expansionary Fiscal Policy increase G decrease T increase transfers

Expansionary and Contractionary Fiscal Policy Contractionary Fiscal Policy decrease G increase T decrease transfers

A Cautionary Note: Lags in Fiscal Policy Time lags Recognition lag Decision lag Implementation lag Lags make decision making more difficult

A Cautionary Note: Lags in Fiscal Policy Recognition lag: The government has to realize that the recessionary gap exists because economic data take time to collect and analyze, and recessions are often recognized only months after they have begun. Decision lag: the government has to develop a spending plan, which can itself take months, particularly if politicians take time debating how the money should be spent and passing legislation. Implementation lag: It takes time to spend money. For example, a road construction project begins with activities such as surveying that don’t involve spending large sums.

Unnumbered Figure 20.1 Is Stabilization Policy Stabilizing? Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

Figure 20.4 Expansionary Fiscal Policy Can Close a Recessionary Gap Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

Figure 20.5 Contractionary Fiscal Policy Can Close an Inflationary Gap Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers