Fiscal Policy Government Intervention in the Free Market?

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Presentation transcript:

Fiscal Policy Government Intervention in the Free Market?

Classical vs. Keynesian Classical Economics | | Keynesian Economics | | Believed in Self-regulation Short Recessions Price Flexible Believed in Government Intervention Long Recessions Price Sticky

John Keynes Argued Government intervention was necessary to moderate the “ups & downs” of business cycle –Recessions could be long or permanent Dominated economics after Great Depression –FDR’s New Deal is an example….

Fiscal Policy Introduction Worksheet AD 1 LRAS 1 Price Level Real GDP SRAS P1P1 Y1Y1 E1E

2 Types of Fiscal Policy Expansionary Policy –Used in recessionary gap Contractionary Policy – Used in inflationary gap Increase Gov’t Spending Decrease Taxes Decrease Gov’t Spending Increase Taxes AD => AD =>

Recessionary Gap Economy below full outputEconomy above full output LRAS 1 Price Level Real GDP SRAS 1 AD 1 Inflationary Gap Expansionary Fiscal Policy Gov’t would lower income taxes => (C↑) Increase Gov’t Spending (G↑) End result: AD shifts right, debt rises Contractionary Fiscal Policy Gov’t would raise income taxes => (C↓) Decrease Gov’t Spending (G↓ ) End result: AD shifts left, debt falls P1P1 Y1Y E1E1