Unit 3: Aggregate Demand and Supply and Fiscal Policy

1. Unit 3:Aggregate Demand and Supply and Fiscal Policy 1

2. Draw and Practice Congress uses discretionary fiscal policy to the manipulate the following economy (MPC = .9) • What type of gap? • Contractionary or Expansionary needed? • What are two options to fix the gap? • How much needed to close gap? LRAS AS P2 Price level AD1 AD -$5 Billion $50FE $100 Real GDP (billions) 3

3. Draw and Practice Congress uses discretionary fiscal policy to the manipulate the following economy (MPC = .8) LRAS • What type of gap? • Contractionary or Expansionary needed? • What are two options to fix the gap? • How much initial government spending is needed to close gap? AS Price level P1 AD2 AD1 +$40 Billion $800 $1000FE Real GDP (billions) 4

4. Problems With Fiscal Policy 5

5. Problems With Fiscal Policy • When there is a recessionary gap what two options does Congress have to fix it? • What’s wrong with combining both? Deficit Spending!!!! • A Budget Deficit is when the government’s expenditures exceeds its revenue. • The National Debt is the accumulation of all the budget deficits over time. • If the Government increases spending without increasing taxes they will increase the annual deficit and the national debt. Most economists agree that budget deficits are a necessary evil because forcing a balanced budget would not allow Congress to stimulate the economy.

7. Paul Solomon Video: Deficit and Debt US Debt Clock

8. Explain this cartoon 2003

9. Who ultimately pays for excessive government spending?

10. Video:Government Stages Coup 11

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13. Additional Problems with Fiscal Policy • Problems of Timing • Recognition Lag- Congress must react to economic indicators before it’s too late • Administrative Lag- Congress takes time to pass legislation • Operational Lag- Spending/planning takes time to organize and execute ( changing taxing is quicker) • Politically Motivated Policies • Politicians may use economically inappropriate policies to get reelected. • Ex: A senator promises more welfare and public works programs when there is already an inflationary gap.

14. Additional Problems with Fiscal Policy 3. Crowding-Out Effect • In basketball, what is “Boxing Out”? • Government spending might cause unintended effects that weaken the impact of the policy. Example: • We have a recessionary gap • Government creates new public library. (AD increases) • Now but consumer spend less on books (AD decreases) Another Example: • The government increases spending but must borrow the money (AD increases) • This increases the price for money (the interest rate). • Interest rates rise so Investment to fall. (AD decrease) The government “crowds out” consumers and/or investors

15. Additional Problems with Fiscal Policy 4. Net Export Effect International trade reduces the effectiveness of fiscal policies. Example: • We have a recessionary gap so the government spends to increase AD. • The increase in AD causes an increase in price level and interest rates. • U.S. goods are now more expensive and the US dollar appreciates… • Foreign countries buy less. (Exports fall) • Net Exports (Exports-Imports) falls, decreasing AD.

16. Explain this cartoon 17

17. Activity 18

18. Unemployment Inflation GDP Growth Good 6% or less 1%-4% 2.5%-5% Worry 6.5%-8% 5%-8% 1%-2% Bad 8.5 % or more 9% or more .5% or less Congressional Committees The Good, the Bad, and the Ugly As a group, analyze the situation, identify the problem, and identify your solution

19. 1.) 1933 Situation: • GDP fell -1.2% • Inflation rate= -.5% • Unemployment Rate=25% Your Solution:

20. 2.) 1944 Situation: • GDP grew 8% • Inflation rate= 3.7% • Unemployment Rate=1.2% Your Solution:

21. 3.) 1980 Situation: • GDP fell -0.3% • Inflation rate= 13.5% • Unemployment Rate=7.1% Your Solution:

22. 4.) 2003 Situation: • GDP fell 0.5% • Inflation rate= 1.5% • Unemployment Rate=12.0% Your Solution:

23. 1.) 1933 Situation: • GDP fell -1.2% • Inflation rate= -.5% • Unemployment Rate=25% Your Solution: What actually happened: • FDR increased public works via the New Deal programs.

24. 2.) 1944 Situation: • GDP grew 8% • Inflation rate= 3.7% • Unemployment Rate=1.2% Your Solution: What actually happened: • War ended the next year and government orders for war materials decreased. • Many public works programs were discontinued

25. 3.) 1980 Situation: • GDP fell -0.3% • Inflation rate= 13.5% • Unemployment Rate=7.1% Your Solution: What actually happened: • The next year, President Regan and congress lowered taxes on individuals and corporations by about 30%. (Supply-side Economics)

26. 4.) 2003 Situation: • GDP fell 0.5% • Inflation rate= 1.5% • Unemployment Rate=12.0% Your Solution: What actually happened: • Congress voted to give tax cuts to citizens. (Bush Tax Cuts)