1. Government Intervention in the Free Market?
Fiscal Policy
Government Intervention in the Free Market?

2. Fiscal Policy
Fiscal Policy is Government’s attempt to moderate the “ups & downs” of business cycle by changing taxes & spending policies
If the Economy is too slow => Gov’t tries to “speed it up”
If the Economy is too fast => Gov’t tries to “slow it down”

3. Inflationary Gap Recessionary Gap Economy above full output
Economy below full output
LRAS1
Price
Level
Real
GDP
SRAS1
LRAS1
Price
Level
Real
GDP
SRAS1
AD1
AD1 P1 Y1 E1 P1 Y1 E1 Y* Y*
Unemployment high, real output low
Below PPF, idle resources
Unemployment very low, output high
Above PPF, no idle resources

4. Fiscal Policy Handout
Introductory Reading

5. 2 Types of Fiscal Policy Expansionary Policy Goal:
Contractionary Policy Goal: AD
Increase Gov’t Spending
Decrease Taxes AD
Decrease Gov’t Spending
Increase Taxes

6. FISCAL POLICY Economy in recession, Unemployment = 9.1%
AD2
Expansionary Fiscal Policy needed P2 E2 Y2
Lower Taxes & ↑ Gov’t spending
C ↑ & G ↑ => AD shifts right
End result: higher GDP, more
Jobs & slightly higher inflation

7. Sample Problem: GDP = +5.0% Unemployment 4.0%
Economy growing “too fast”
Contractionary Fiscal Policy needed
AD2
Raise Taxes & ↓Gov’t spending
C ↓ & G ↓ => AD shifts left
End result: lower GDP, less
Jobs & slightly lower inflation