1. Macro Chapter 11 Fiscal Policy

2. Quick Review #1 Answer: E

3. Quick Review #2 Which of the following transactions would represent an addition to a nation’s current gross domestic product? A. Ms. Smith purchases a share of stock in an automobile company B. A retailer increases her stock of imported shoes C. The government increases its domestic purchases of food for use by the military D. A corporation sells shoes from last year’s inventory E. A mother sells her car to her daughter Answer: C

4. Quick Check #3 Goods and services that are purchased for resale or for further processing or manufacturing Intermediate Goods

5. Quick Check #4 When unemployed people lack the skills or education, or geographically are misplaced to find work Structural Unemployment

6. Council of Economic Advisors (CEA) Group of 3 economists appointed by the President to advise him on economic policy- mostly professors of economics Obama and former Chr. Austin Goolsbee

7. Fiscal Policy Fiscal = “Financial” Changes in government spending and taxation designed to achieve full employment, control inflation, and encourage economic growth

8. Expansionary Fiscal Policy Used during a recession to stimulate the economy Government has 3 Choices: 1.Increase government spending 2.Reduce taxes 3.Combo of both

9. 1. Increased Gov’t Spending Ceteris Paribus, an increase in govt spending will shift the AD to the right New spending on highways, schools, etc. will lead to more GDP ***the multiplier leads to an even greater increase in demand

10. Fiscal Policy and the AD-AS Model Real Domestic Output, GDP Price Level AD 1 Recessions Decrease Aggregate Demand AD 2 $5 Billion Additional Spending Full $20 Billion Increase in Aggregate Demand AS $490$510 P1P1 Expansionary Fiscal Policy

11. 2. Reduce Taxes Reducing taxes will also shift the AD curve to the right ***Tax cuts must be greater than the increase in govt spending to achieve the same shift in GDP due to people saving part of a tax cut

12. Tax Cuts and Real GDP 1. Change in GDP = tax cut (MPC) x multiplier 2. Tax Multiplier = -MPC/MPS

13. Reduced Taxes Example If the govt cuts taxes by $6.67 Billion and the MPC is.75, what is the total change in GDP? 6.67 x.75 = $5 billion consumed, and $1.67 B saved $5 B x 4 (multiplier 1/.25) = increase of $20 B in GDP

14. 3. Combo of Govt Spending and Tax Cuts Ex- $1.25 B in increased government spending and $5 B tax cut with an MPC of.75 Govt spending = 1.25 x 4 = $5 B Tax Cut = 5 x.75 = $3.75 B increase x 4 = $15 $5 B + $15 B = $20 B increase in GDP

15. Contractionary (Restrictive) Fiscal Policy Used to fight inflation 3 Options: 1. decrease govt spending 2. raise taxes 3. combo of the two

16. 1. Decreased Govt Spending Decreased spending shifts the AD curve to the left If prices are inflexible downwards, this policy will stop the inflation rather than return to original price level

17. 2. Increased Taxes Reduces consumption spending since people will have less disposable income

18. 3. Combo Reduced Spending and Tax Increase Ex- $2 B decline in spending coupled with a $4 B increase in taxes (MPC of.75) Spending = 2 x 4 (multiplier) = $8 B Taxes = 4 x.75 = 3 x 4 (multiplier) = $12 B $8 B + $12B = decrease of $20 B in GDP

19. Fiscal Policy and the AD-AS Model Real Domestic Output, GDP Price Level AD 3 Recessions Decrease Aggregate Demand AD 4 $5 Billion Initial Decrease In Spending Full $20 Billion Decrease in Aggregate Demand AS $510$530 P1P1 Contractionary Fiscal Policy