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Survey of Economics Irvin B. Tucker
Chapter 15 Fiscal Policy Lecture Slides Survey of Economics Irvin B. Tucker © 2016 south-Western, a part of Cengage Learning
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What will I learn in this chapter?
How the federal government uses discretionary fiscal policy to influence the economy’s performance © 2016 south-Western, a part of Cengage Learning
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What is discretionary fiscal policy?
The deliberate use of changes in government spending or taxes to alter aggregate demand © 2016 south-Western, a part of Cengage Learning
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Expansionary Fiscal Policy
Exhibit 15-1 Expansionary Fiscal Policy Increase government spending Decrease taxes Increase government spending and taxes equally © 2016 south-Western, a part of Cengage Learning
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Decrease government spending Increase taxes
Exhibit 15-1 Contractionary Fiscal Policy Decrease government spending Increase taxes Decrease government spending and taxes equally © 2016 south-Western, a part of Cengage Learning
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Increase in price level and real GDP
Increase in aggregate demand curve Increase in government spending or decrease in taxes © 2016 south-Western, a part of Cengage Learning
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(trillions of dollars per year)
Exhibit 15-2 Using Government Spending to Combat a Recession AS E2 215 E1 Price Level (CPI) X 210 AD2 AD1 Full employment 13 14 15 Real GDP © 2016 south-Western, a part of Cengage Learning (trillions of dollars per year)
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What is the spending multiplier?
Any initial change in spending leads to a chain reaction of more spending which causes a greater change in demand © 2016 south-Western, a part of Cengage Learning
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How is the spending multiplier calculated?
The ratio of the change in real GDP to an initial change in any component of aggregate expenditures © 2016 south-Western, a part of Cengage Learning
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What is the marginal propensity to consume (MPC)?
MPC is the change in consumption resulting from a change in income © 2016 south-Western, a part of Cengage Learning
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The spending multiplier formula
Spending multiplier (SM) = 1/(1-MPC) © 2016 south-Western, a part of Cengage Learning
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With an MPC of 0.50, what is the spending multiplier?
© 2016 south-Western, a part of Cengage Learning
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How much will real GDP increase with an increase in government spending of $1,000 billion?
∆G X SM = ∆Y $1,000Bn x 2 = $2,000Bn © 2016 south-Western, a part of Cengage Learning
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Exhibit 15-3 The Spending Multiplier Effect
Component of Total Sending New Consumption Spending (billions of dollars) Round Government spending $1,000 Consumption Consumption Consumption All other rounds Consumption Total spending $2,000 © 2016 south-Western, a part of Cengage Learning
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Exhibit 15-4 Relation Between MPC and the Spending Multiplier
(1) (2) (3) Marginal Propensity to Consume (MPC) Marginal Propensity to Save (MPS) Spending Multiplier (SM) © 2016 south-Western, a part of Cengage Learning
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What is the tax multiplier?
The change in aggregate demand (total spending) resulting from an initial change in taxes © 2016 south-Western, a part of Cengage Learning
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What is the tax multiplier formula?
TM = 1 – spending multiplier © 2016 south-Western, a part of Cengage Learning
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With a spending multiplier of 2 what is the tax multiplier (TX)?
© 2016 south-Western, a part of Cengage Learning
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How much does real GDP increase by with a cut in taxes of $1,000Bn?
∆ T x TM = ∆Y 1 x $1,000B = $1,000Bn © 2016 south-Western, a part of Cengage Learning
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What will happen to AD if both government spending (G) and taxes are increased by $1,000 Bn?
© 2016 south-Western, a part of Cengage Learning
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Exhibit 15-5 Comparison of the Spending and Multipliers
Increase in Aggregate Demand from a (1) (2) $1 Trillion increase in Government Spending (x G) $1 Trillion Cut in Taxes (- T) Component of Total Sending ∆ ∆ Round Government spending $1, $ 0 Consumption Consumption Consumption All other rounds Consumption Total spending $2, $1,000 © 2016 south-Western, a part of Cengage Learning
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What is the conclusion? A tax cut has a smaller multiplier effect on aggregate demand than an equal increase in government spending © 2016 south-Western, a part of Cengage Learning
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Can we assume that the MPC will remain fixed?
No, it can change from one time period to another © 2016 south-Western, a part of Cengage Learning
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Can fiscal policy be used to combat inflation?
Yes, this would happen when the economy is operating in the intermediate or classical ranges of the aggregate supply curve © 2016 south-Western, a part of Cengage Learning
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Decrease in price level and real GDP
Decrease in aggregate demand curve Decrease in government spending or increase in taxes © 2016 south-Western, a part of Cengage Learning
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Exhibit 15-6 Using Fiscal Policy to Combat Inflation
AS E´ E1 220 Price Level (CPI) E2 215 AD1 AD2 Full employment 13 14 Real GDP © 2016 south-Western, a part of Cengage Learning (trillions of dollars per year)
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What is an automatic stabilizer?
Federal expenditures and tax revenues that automatically change levels in order to stabilize an economic expansion or contraction © 2016 south-Western, a part of Cengage Learning
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What are examples of automatic stabilizers?
Transfer payments Unemployment compensation Welfare Tax collections © 2016 south-Western, a part of Cengage Learning
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Budget surplus offsets inflation
Tax collections rise and government transfer payments fall Increase in real GDP © 2016 south-Western, a part of Cengage Learning
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What is a budget surplus?
A budget in which government revenues exceed government expenditures in a given time period © 2016 south-Western, a part of Cengage Learning
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Budget deficit offsets recession
Tax collections fall and government transfer payments rise Decrease in real GDP © 2016 south-Western, a part of Cengage Learning
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What is a budget deficit?
A budget in which government expenditures exceed government revenues in a given time period © 2016 south-Western, a part of Cengage Learning
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T G T G 12 Exhibit 15-7 Automatic Stabilizers 2.5 2.0 Budget deficit
Budget surplus 1.5 Government Spending and Taxes (trillions of dollars per year) 1.0 T G 0.5 12 14 16 Real GDP © 2016 south-Western, a part of Cengage Learning (trillions of dollars per year)
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