Principles of MacroEconomics: Econ101

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What is Fiscal Policy Automatic Discretionary

The Multiplier Effect Revisited Government Spending Taxes

Expansionary vs. Contractionary Fiscal Policy

The Crowding Out Effect

Deficits, Surpluses and Federal Government Debt

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Changes in government expenditures and/or taxes to achieve particular economic goals, such as low unemployment, stable

prices, and economic growth.

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Automatic Fiscal Policy:Changes in government expenditures and/or taxes that occur automatically without (additional) congressional action…..automatic stabilizers.

Entitlements such as: Unemployment benefits Welfare spending Social Security spending Income Taxes

Each one percentage point increase in the unemployment rate will increase government

spending by about $5 billion and will decrease tax revenues approximately $25 billion for a total budget

deficit of $30 billion.

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Discretionary Fiscal Policy:Deliberate changes of government expenditures and/or taxes to achieve particular

economic goals. Government spending Taxation Changing Transfers Not as successful as automatic fiscal policy

Tax/transfer Multiplier = Marginal Propensity to Consume 1 – Marginal Propensity to Consume

The multiplier is a number that multiplies a change in taxes or transfers in order to calculate the change in real GDP.

The tax & transfer multiplier is lower than the government purchases multiplier because if government purchases goods and services, every dollar is spent to buy goods or

services. If government reduces taxes, only part of that money is spent to buy goods and services.

Therefore, increasing government purchases has a larger effect, dollar for dollar than reducing taxes or increasing transfers.

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Multiplier effect: The series of induced increases in consumption spending that results from an initial increase in autonomous expenditures.

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Structural Deficit:

The part of the budget deficit that would exist even if the economy were operating at full employment.

Only reason that structural can change from year to year is that the federal government took some specific action to change government spending or tax revenues.

The structural budget deficit or surplus measures the intent of fiscal policy

Official Budget Deficit:

The part of the budget deficit that is a result of a downturn in economic activity.

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Expansionary Fiscal Policy:

Increases in government expenditures and/or decreases in taxes to achieve particular economic goals.

Contractionary Fiscal Policy:

Decreases in government expenditures and/or increases in taxes to achieve particular economic goals.

PROBLEM

TYPE OF POLICY

ACTIONS BY CONGRESS AND THE PRESIDENT RESULT

Recession Expansionary Increase government spending or cut taxes

Real GDP and the price level rise.

Rising Inflation

Contractionary

Decrease government spending or raise taxes

Real GDP and the price level fall.

Don’t Let This Happen to YOU!Don’t Confuse Fiscal Policy and Monetary Policy 8

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Increased government purchases, decreased taxes, or both lead to a

rightward shift in the aggregate demand curve from AD1 to AD2,

restoring the economy to the natural level of Real GDP, QN

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Decreased government purchases, increased taxes, or

both lead to a leftward shift in the aggregate demand curve from

AD1 to AD2, restoring the economy to the natural level of

Real GDP, QN.

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In this scenario, the SRAS curve is shifting rightward (healing the economy of its recessionary gap), but this information is unknown to policymakers.

Policymakers implement expansionary fiscal policy, and the AD curve ends up intersecting SRAS2 at point 2instead of intersecting SRAS1 at point1'.

Policymakers thereby move the economy into an inflationary gap, thus destabilizing the economy.

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The decrease in private expenditures that occurs as a consequence of increased government spending (direct effect) or the financing needs of

the Federal budget deficit (indirect effect).

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Budget deficit:The situation in which the government’s spending is greater than its tax revenue.

Budget Surplus:The situation in which the government’s expenditures are less than its tax revenue.

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