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Econ 201 Week 16 (Govt and Fiscal Policy)

by: Ekene Tharpe

Econ 201 Week 16 (Govt and Fiscal Policy) ECON 201

Marketplace > University of Tennessee - Knoxville > Economcs > ECON 201 > Econ 201 Week 16 Govt and Fiscal Policy
Ekene Tharpe

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Covers all of week 16 notes and all aspects of government and fiscal policy.
Intro Economics: Survey Course
Donna Bueckman
Class Notes
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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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