Econ 201 Week 16 (Govt and Fiscal Policy)
Econ 201 Week 16 (Govt and Fiscal Policy) ECON 201
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This 4 page Class Notes was uploaded by Ekene Tharpe on Monday May 2, 2016. The Class Notes belongs to ECON 201 at University of Tennessee - Knoxville taught by Donna Bueckman in Fall 2015. Since its upload, it has received 15 views. For similar materials see Intro Economics: Survey Course in Economcs at University of Tennessee - Knoxville.
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Date Created: 05/02/16
Econ 201: Week 16 Fiscal Policy • Setting the level of govt spending and taxation by govt policymakers o Expansionary or contractionary o Discretionary (deliberate manipulation) o Non-‐discretionary (automatic) Fiscal Policy and Aggregate Demand • Fiscal Policy (G) and taxation (T) by govt policymakers • Expansionary Fiscal Policy: o An increase in G and/or decrease in T o Shifts AD right • Contractionary Fiscal Policy: o A decrease in G and/or increase in T o Shifts AD left Expansionary Fiscal Policy G increases LRAS Taxes decrease SRAS P 2 B A P 1 2 effects Fiscal Policy has on AD: AD 1 1. The multiplier effect Y Y 2. The crowding out effect 1 N Output/Recessionary gap The Multiplier Effect • Additional shifts in AS the result when fiscal policy increases income and thus increases consumer spending Ex: G buys $20bil of interstate construction from contactors • Wholesale revenue increases by $20bil • Distributed in wages and profits • People who are consumers spend money (“rinse and repeat”) A $20bil increase in G initially shifts AD to the AD AD A1 2 3 right by $20bil. BUT THEN the increase in Y P 1 causes C to rise, which shifts AD further to the right. $20 bil Y 1 2 3 Y Marginal Propensity to Consume • How big is the multiplier effect? o Depends on how consumers respond to additional income (spend, save?) • Marginal propensity to consume (MPC): o The fraction of extra income that households consume rather than save § So if MPC= .8 and income rises $100, C rises $80 § 80: C = MPC Y ( = change in) A Formula for the Multiplier Notion: G is the change in G Y and C are the ultimate changes in Y and C Y= C + I + G + NX -‐-‐-‐ identity Y = C + G -‐-‐-‐ I and NX don’t change because C= MPC Y Y = (1)/(1-‐MPC) G-‐-‐-‐-‐ solved for Y The multiplier • A bigger MPC means changes in Y cause bigger changes in C. • In turn, cause more changes in Y • Size of multiplier depends on MPC o If MPC= .5 multiplier = 2 o If MPC= .9 multiplier = 10 • The multiplier magnifies any autonomous change The Crowding-‐Out Effect AD AD1 2 3 • Govt borrowing and spending shifts AD to the right P 1 o Also raises r o Which reduces I o Which reduces AD $20bil • So the AD shift my be smaller than the multiplier would suggest • This is called the Crowding-‐out effect. Y 1 2 3 Y Fiscal Policy Ag Supply • Most economics believe: o SR effects of fiscal policy mainly work through AD • Fiscal policy might also effect AS o Ex: income tax cut, work more • People who believe this effect is large are called “supply-‐siders” The Case for Active Stabilization Policy • Keynes: o “Animal spirits”: pessimism and optimism among households and firms o Booms and recessions abroad o Stock market booms and crashes o “long-‐run” • If policymakers do nothing, the fluctuations: o Change AD, output, and employment o Are destabilizing to businesses, workers, and consumers • The Lag Argument: o Recognition lag o Legislative lag (takes an act of congress) o Implementation lag *policy can end up being pro-‐cyclical Automatic Stabilizers • Changes in fiscal policy that stimulates AD when the economy goes into recession, w/o policy makers having deliberate action • Examples: o Personal income tax: progressive tax-‐ tax rates rise with increasing income o Unemployment insurance o “Social safety net” programs Budget Deficits and Surpluses • Budget Surplus o Excess of tax revenue over govt spending o = T – G o = Public saving • Budget Deficit o Shortfall of tax revenue from govt spending o = G – T o = -‐ (public saving) • … financed by selling govt securities (treasury) The U.S Govt Debt • Govt debt = accumulated deficits • Debt to GDP ratio: o Measure of the govts indebtedness relative to its ability to raise tax revenue Where we are vs. Where we can be • U.S economy is large • Can’t change the direction of anything ‘big’ quickly. (think aircraft carrier) • Change is necessary • Slow change is crucial • Leaders change directions o Make sound economic decisions (#s matter, be informed) • VOTE for better decision makers • What they do in DC matters
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