Unit 3 - Ch 11- Adjusted

7/26/2019 Unit 3 - Ch 11- Adjusted

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Copyright 2012 by McGraw-Hill RyersonLimited. ll rights reser!ed.

Understanding Economics6thedition

by Mark Lovewell


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UnderstandingEconomics

Chapter 11

Fiscal Policy

Copyright 2012 by McGraw-Hill Ryerson Limited. ll rights reser!ed.

"theditionby Mar# Lo!ewell


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Learning $b%ecti!es&ter this chapter yo' will be able to(

1. identi&y e)pansionary and contractionary*scal policies+ which are 'sed by go!ernments

see#ing economic stability2. o'tline the m'ltiplier e,ect o& *scal policy+ as

determined by the marginal propensities tocons'mer and withdraw

. disting'ish b'dget s'rpl'ses and de*cits andtheir impact on p'blic debt and p'blic debtcharges



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tabili/ation olicies a tabili/ation policy is go!ernment policy

designed to lessen the e,ects o& the b'sinesscycle.3t can be either e)pansionary or contractionary.

4)pansionary policy attempts to red'ce'nemployment and stim'late o'tp't.

Contractionary policy attempts to stabili/eprices and red'ce o'tp't.



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tabili/ation olicy and the 5'sinessCycle6ig're 11.1+ age 00


C$78RC83$7 4973$7

ea#

8ro'gh

Long-R'n 8rend

o& otential$'tp't

:itho't stabili/ationpolicy

:ith stabili/ationpolicy

Rea

lG;

8ime


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tabili/ation olicies b tabili/ation policy can ta#e the &orm o& either

*scal policy or monetary policy.6iscal policy 'ses ta)es and go!ernment

p'rchases. 4)pansionary *scal policy in!ol!es more go!ernment

p'rchases and


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4)pansionary 6iscalolicy6ig're 11.2+ page 01


AS

AD0 AD1

b

a

otential $'tp't

3nitial

RecessionaryGap

Real G; 2002 = billions

>00?>00

1?0

1"0

rice

Le!e

lG;de

@a

tor+

2002A1

00


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Contractionary 6iscal olicy6ig're 11.+ age 02


>10>000

1B0

1?0

Real G; 2002 = billions

rice

Le!e

lG;de

@a

tor+

2002A

1

00

AS

AD0

AD1otential $'tp't

3nitial

3n@ationary Gap

d

c


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;iscretionary olicies ers's

'tomatic tabili/ers;iscretionary policy is intentional go!ernment

inter!ention in the economy. 'tomatic stabili/ers are b'ilt-in meas'res

s'ch as ta)es and trans&er payments to lessenthe e,ects o& the b'siness cycle. contracting economy decreases net ta)

re!en'es which increases spending and incomes.n e)panding economy increases net ta)

re!en'es which decreases spending and incomes.



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8he M'ltiplier 4,ect a8he m'ltiplier e,ect is the magni*ed impact

o& a spending change on ;.n initial spending change prod'ces income

and part o& this new income becomes newspending.

8his process is repeated with each spendingro'nd smaller than the last.



11/29


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8he 4,ect o& a Rise in Go!ernment'rchases6ig're 11.D+ age 0"


2000

1000

01st

ro'nd

2nd

ro'nd

rd

ro'nd

Later

spendingro'nds

Cycles o& pending

3ncrease

inRe

al$'

tp'

t2000

1000

01st

ro'nd

2nd

ro'nd

rd

ro'nd

Later

spendingro'nds

E00

3ncrease

in:ithdrawa

ls

=1000

=E00

=2E0

=2E0

=2E0

=2E0

=E00

=0


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8he pending M'ltiplier8he spending m'ltiplier(is the !al'e by which an initial spending change

is m'ltiplied to gi!e the total shi&t in the ;c'r!e

eF'als 1


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8he M'ltiplier 4,ect and rice Changes

6ig're 11.E+ age 0B


Real G; 2002 = billions>0E?>00

1"0

1E0

rice

Le!e

lG;de

@a

tor+

2002A

100

>10

AS

AD0 AD1

a b

c


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Changes in Go!ernment 'rchases

ers's 8a) Changes change in go!ernment p'rchases ca'ses an

initial spending change o& the same amo'ntand in the same direction.

ta) change has a smaller initial impact onspending and in the opposite direction.8he initial spending change is &o'nd by

m'ltiplying the ta) change by the marginal

propensity to cons'me and then re!ersing thesign o& this change.



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8he 5ene*ts and ;rawbac#s o& 6iscal

olicy 6iscal policy has two main bene*ts(3t can be &oc'sed on partic'lar regions.

3t has a relati!ely direct impact on spending.

6iscal policy has three main drawbac#s(3t is s'b%ect to delays recognition lag+ decision

lag+ impact lag.

3t is closely related to p'blic debt+ which is thetotal amo'nt owed by the &ederal go!ernmentas a res'lt o& past borrowing.



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8he 3mpact o& 6iscal

olicy a go!ernment is r'nning a(balanced b'dget when its e)pendit'res and

re!en'es are eF'al

b'dget s'rpl's when its re!en'es e)ceed itse)pendit'res

b'dget de*cit when its e)pendit'res e)ceed itsre!en'es



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8he 3mpact o& 6iscal

olicy b:hen a go!ernment has a(b'dget de*cit its debt increases by the same

amo'nt

b'dget s'rpl's its debt decreases by the sameamo'nt

3n the past the &ederal go!ernment tended tor'n b'dget de*cits.

5eca'se o& past borrowing the &ederalgo!ernment pays large p'blic debt charges.



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8he ;ebate $!er 'blic ;ebt a8hose who s'pport 'sing p'blic debt say(p'blic debt pro!ides bene*ts by red'cing the

costs o& 'nemployment

abo't >0 percent o& go!ernment debt is held byCanadians+ or owed to o'rsel!es

when debt is 'sed to create prod'cti!e assets+it is not necessarily a problem

there ha!e been times in the past when p'blicdebt as a percent o& G; was higher than now



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8he ;ebate $!er 'blic ;ebt b8hose against 'sing p'blic debt say(p'blic debt charges rose 'ntil recently

pro!incial and territorial debts need to be ta#eninto acco'nt as well

there are limits to how m'ch ta)es can beraised to pay p'blic debt charges

there are potential &'t're b'rdens associatedwith the crowding-o't e,ect and the amo'nt o&Canadas go!ernment debt held by &oreigners



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'blic ;ebt and G;6ig're + page 2E


1"2#-1"2$1"%#-1"%$

1"-1"&$

1"'#-1"'$

1"##-1"#$

1"$#-1"$$

1"(#-1"($

1""#-1""$200#-200$

2010-2011

2.%%.1

12.$

11.&

1$.$

&1.'

2'$.$

'#2."$.%

''#.&

#$

10$

%'

2$

21

'0

#$%2

%&

2.'%.0

%."

1.'

1.(

2.&

'.#

'.#2.%

1."

Year Public Debt(billions of

current-year $)

Public Debt(% of

nominal GDP)

Public DebtCharges (% ofnominal GDP)


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8he 3mpact o& Go!ernment $LCa

:hen go!ernment is incorporated in theaggregate e)pendit'res model+ we ass'methat 8 is a l'mp-s'm amo'nt o& =200 billion at

e!ery G; le!el. Li#ewise G is =200 billion.:hile G is added directly to the 4 line+ the

e,ect o& ta)es is indirect. :ith an MC o& .?E+a =200 billion rise is ta)es will ca'se C to &all

by =1E0 billion at e!ery G; le!el.



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8he 3mpact o& Go!ernment $LCb

ince 4 rises by =200 billion d'e to G and&alls by =1E0 billion d'e to 8+ the o!erall risein the 4 line is =E0 billion.

s a res'lt+ eF'ilibri'm G; e)pands by =200billion.



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8he 3mpact o& Go!ernment $LCc6ig're contin'ed in part e


0200D00"00>00

100012001D00

E0200E0E00"E0>00BE0

1100

2E2E2E2E2E2E2E2E

2E2E2E2E2E2E2E2E

00DE0"00?E0B00

10E012001E0

200 D00 "00 >00 1000 1200 1D00

0

200

D00

"00

>00

1000

1200

1D00

G; = billions

4)pen

dit'res

=billions

AE0= C0+ I + (X !

AE1= C0+ I + " +(X !

AE#= C1+ I + " +(X !

a

c

Change in

C A -=1E0b.

G A=200b.

DE

S$ending%&'t$'t A$$roac

G; C 3 9-M 4= billions

G

200200200200200200200200


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8he 3mpact o& Go!ernment $LCd

:hen go!ernment is incorporated in thein%ections-withdrawals approach+ in%ectionsrise by =200 billion.

8here are two e,ects on withdrawals(8otal withdrawals rise by =200 billion d'e to the

addition o& 8.8otal withdrawals &all beca'se o& a drop in

sa!ing. :ith an M o& .2E+ a =200 billion rise inta)es ca'ses to &all by =E0 billion.$!erall+ total withdrawals rise by =1E0 billion+

while eF'ilibri'm o'tp't e)pands.



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8he 3mpact o& Go!ernment $LCe6ig're + contin'ed &rom part c


S0+ ) +

S1+ ) +

S0+

I + X

I + " + X

Change in A -=E0b.

8 A=200b b

d

200 D00 "00 >00 1000 1200 1D00

G; = billions

0

200

D00

"00

-200

3n%ec

tions+

:ithdraw

als=billions

0

200D00"00>00

100012001D00

-2E0

-200-1E0-100-E0

0E0

100

200

200200200200200200200

200

200200200200200200200

?E

?E?E?E?E?E?E?E

E0

E0E0E0E0E0E0E0

00

E0D00DE0E00EE0"00"E0

2E

2E2E2E2E2E2E2E

In*ections%itdra,als A$$roac

G; 8 G 9= billions

M I8IM 3 3IGI9

"00

"00"00"00"00"00"00"00


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8he 3mpact o& Go!ernment $LC

8he 5alanced 5'dget M'ltiplier8he impact o& incorporating go!ernment on

eF'ilibri'm G; can be shown 'sing thebalanced b'dget m'ltiplier.8he change in o'tp't d'e to a change in both G

and 8 by the same dollar amo'nt ie. =200billion is shown by the &ollowing &orm'la(

change in o'tp't A 1 ) change in G or 8



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8he 3mpact o& Go!ernment $LCggregate ;emand and ggregate

'pply a8he aggregate e)pendit'res model can be

interpreted 'sing aggregate demand andaggregate s'pply i& we remember that in this

model the price le!el is ass'med to beconstant+ so that is hori/ontal.



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UnderstandingEconomics

Chapter 11

)e EndCopyright 2012 by McGraw-Hill Ryerson Limited. ll rights reser!ed.

"theditionby Mar# Lo!ewell

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Unit 3 - Ch 11- Adjusted

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