1. Macroeconomic Policy and the AD-AS Model Stabilization Policies and Their Effects

2. E2E2 Expansionary Fiscal Policy: Addressing Recessionary Gaps Suppose a negative demand shock has caused a recession. AD 2 AD 1 Aggregate Price Level Real GDP SRAS The shift leads to a higher aggregate price level AND Y1Y1 YPYP P1P1 P2P2 E1E1 higher aggregate output. Using fiscal policy, how could a government address this problem? LRAS Potential output Recessionary gap The government’s goal is to stabilize the economy by bringing it to long-run economic equilibrium (E 2 in the figure above)

3. Government Policy and Negative Demand Shocks What could the government do in terms of FISCAL POLICY to address a recessionary gap? What are some “expansionary fiscal policies”?

4. E2E2 Contractionary Fiscal Policy: Addressing Inflationary Gaps AD 2 AD 1 Aggregate Price Level Real GDP SRAS The shift leads to a lower aggregate price level AND Y1Y1 YPYP P1P1 P2P2 E1E1 lower aggregate output. LRAS Potential output Inflationary gap The government’s goal is to stabilize the economy by bringing it to long-run economic equilibrium (E 2 in the figure above) Suppose a positive demand shock has caused high inflation. Using fiscal policy, how could a government address this problem?

5. Government Policy and Positive Demand Shocks What could the government do in terms of FISCAL POLICY to address an inflationary gap? What are some “contractionary fiscal policies”?

6. E2E2 Hard Macroeconomic Choices: Recession Caused by Supply Shocks Suppose a negative supply shock has caused a recessionary gap. AD 2 AD 1 Aggregate Price Level Real GDP SRAS The shift leads to a higher aggregate price level AND Y1Y1 YPYP P1P1 P2P2 E1E1 higher aggregate output. Aggregate prices are higher and output lower than at long-run equilibrium (stagflation). The government has addressed the recessionary gap… but at what cost? LRAS Potential output In order to bring the economy back to long-run equilibrium, what if the government increases aggregate demand? Recessionary gap What would have happened if the government tried to lower aggregate demand?

7. Well this looks easy… why doesn’t the government ALWAYS use fiscal policy?? The danger of lags: What is “recognition lag”? What is “decision lag”?

8. Scenarios—answer and graph (the type of policy, the change to rGDP, and the effects to the AD-AS model) 1.Several military bases around the country, which together employ tens of thousands of people, are closed. 2.The number of weeks an unemployed person is eligible for unemployment benefits increased. 3.The federal tax on gasoline is increased. 4.A new space race for Mars begins with Russia and China. 5.Elderly people storm the Capitol as Congress announces Social Security cuts. 6.Income tax rates are cut across the board.

9. AP Macro National Exam Free-Response Questions 1.The economy is currently experiencing a recessionary gap—show this in a graph. a.List two fiscal policy options that would move the economy closer to potential real GDP. b.Describe AND UPDATE YOUR GRAPH to show how your policies would achieve the desired result. 2.The economy is currently at a level of output that exceeds potential GDP (Y P ). a.List two fiscal policy options that would move the economy closer to potential real GDP. b.Describe AND UPDATE YOUR GRAPH to show how your policies would achieve the desired result.