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Macro Chapter 11

Macro Chapter 11 . Fiscal Policy. Quick Review #1. Answer: E . Quick Review #2. If higher US interest rates cause foreign demand for the dollar to increase, which of the following will occur to the international value of the dollar and to US exports?

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Macro Chapter 11

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  1. Macro Chapter 11 Fiscal Policy

  2. Quick Review #1 • Answer: E

  3. Quick Review #2 • If higher US interest rates cause foreign demand for the dollar to increase, • which of the following will occur to the international value of the dollar • and to US exports? • International Value of the DollarExports • A. Increase Increase • B. Increase Decrease • C. Increase No Change • D. Decrease Increase • E. Decrease Decrease • Answer: B

  4. Quick Review #3 • Which of the following transactions would represent an addition to a nation’s current gross domestic product? • A. Ms. Smith purchases a share of stock in an automobile company • B. A retailer increases her stock of imported shoes • C. The government increases its domestic purchases of food for use by the military • D. A corporation sells shoes from last year’s inventory • E. A mother sells her car to her daughter • Answer: C

  5. Council of Economic Advisors (CEA) • Group of 3 economists appointed by the President to advise him on economic policy- mostly professors of economics • Obama and former Chr. Austin Goolsbee

  6. Fiscal Policy • Fiscal = “Financial” • Changes in government spending and taxation designed to achieve full employment, control inflation, and encourage economic growth

  7. Expansionary Fiscal Policy • Used during a recession to stimulate the economy Government has 3 Choices: • Increase government spending • Reduce taxes • Combo of both

  8. Fiscal Policy and theAD-AS Model Expansionary Fiscal Policy Full $20 Billion Increase in Aggregate Demand $5 Billion Additional Spending AS Recessions Decrease Aggregate Demand Price Level P1 AD1 AD2 $490 $510 Real Domestic Output, GDP

  9. 1. Increased Gov’t Spending • Ceteris Paribus, an increase in govt spending will shift the AD to the right • New spending on highways, schools, etc. will lead to more GDP • ***the multiplier leads to an even greater increase in demand

  10. 2. Reduce Taxes • Reducing taxes will also shift the AD curve to the right • ***Tax cuts must be greater than the increase in govt spending to achieve the same shift in GDP due to people saving part of a tax cut

  11. Reduced Taxes Example • If the govt cuts taxes by $6.67 Billion and the MPC is .75, what is the total change in GDP? • 6.67 x .75 = $5 billion consumed, and $1.67 B saved • $5 B x 4 (multiplier 1/.25) = increase of $20 B in GDP

  12. 3. Combo of Govt Spending and Tax Cuts • Ex- $1.25 B in increased government spending and $5 B tax cut with an MPC of .75 • Govt spending = 1.25 x 4 = $5 B • Tax Cut = 5 x .75 = $3.75 B increase x 4 = $15 • $5 B + $15 B = $20 B increase in GDP

  13. Contractionary (Restrictive) Fiscal Policy • Used to fight inflation • 3 Options: • 1. decrease govt spending • 2. raise taxes • 3. combo of the two

  14. 1. Decreased Govt Spending • Decreased spending shifts the AD curve to the left • If prices are inflexible downwards, this policy will stop the inflation rather than return to original price level

  15. 2. Increased Taxes • Reduces consumption spending since people will have less disposable income

  16. 3. Combo Reduced Spending and Tax Increase • Ex- $2 B decline in spending coupled with a $4 B increase in taxes (MPC of .75) • Spending = 2 x 4 (multiplier) = $8 B • Taxes = 4 x .75 = 3 x 4 (multiplier) = $12 B • $8 B + $12B = decrease of $20 B in GDP

  17. Fiscal Policy and theAD-AS Model Contractionary Fiscal Policy Recessions Decrease Aggregate Demand $5 Billion Initial Decrease In Spending AS Price Level Full $20 Billion Decrease in Aggregate Demand P1 AD4 AD3 $510 $522 Real Domestic Output, GDP

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