1. Chapter Five Government and Fiscal Policy

2. 1. Government Sector Government affects the economy in two ways: G;TR G;TR and TA and TA Fiscal policy is the policy of government with regard to the level of Government purchases, transfer payments, and the tax structure. is the policy of government with regard to the level of Government purchases, transfer payments, and the tax structure.

3. 2. Equilibrium income The equation: The equation: AD = C + I + G + NX AD = C + I + G + NX Equilibrium condition: Equilibrium condition: AD = Y AD = Y So, So, Y*= A /{1-MPC(1-t) } Y*= A /{1-MPC(1-t) }

4. 3. Effects of a Change in Government Purchases and G multiplier Purchases and G multiplier 45° YY’ ∆G AD Y ∆Y ? AD AD’

6. 4. Effects of Transfer Payments and TR Multiplier Multiplier 45° YY’ ∆TR AD Y ∆Y ? Y”

7. 5. Effects of an Income Tax Change and t Multiplier Multiplier Assume the income tax rate increases, Assume the income tax rate increases, what is the effects on the economy? And what is the tax rate multiplier? And what is the tax rate multiplier?

8. Income tax effects I II ∆Y AD AD’ AD Y

9. 6. Automatic stabilizers is any mechanism in the economy that automatically---that is,without case by case government intervention----reduces the amount by which output changes to a change in autonomous demand. is any mechanism in the economy that automatically---that is,without case by case government intervention----reduces the amount by which output changes to a change in autonomous demand.

10. 7. The Budget Definition: Budget surplus BS = TA - G - TR = tY - G - TR BS = TA - G - TR = tY - G - TR The Effects of Government Purchases and Tax Changes on the Budget Surplus A Simultaneous Change in Taxes and Purchases Balanced Budget Multiplier