Ch. 13 Flashcards
(11 cards)
That deliberate changes in government spending and net taxes are known as (discretionary)
Fiscal Policies, which are controlled by Congress, and the difference between expansionary and
contractionary policies
Definition: Deliberate changes in government spending and/or net taxes
Control: Implemented by the government’s legislative branch (e.g., Congress in the U.S.).
Purpose: Used to influence the economy’s overall level of aggregate demand.
Expansionary Fiscal Policy: useful during a recession when we want to expand spending & GDP, shift AD right, towards LRAS
increases gov. spending or decreases taxes
(DONE IN THE US)
Contractionary Policies: useful during an expansionary gap when we want to contract, spending & GDP shift AD left
gov purchases decrease; taxes increase
( NEVER DONE IN THE US)
That fiscal policy involves changes to government purchases (which directly changes aggregate
spending) as well as changes to taxes and transfers (which indirectly changes spending as
households see their spendable income change)
Gov purchases:
Direct Impact: When the government increases its spending on goods and services, it directly adds to aggregate demand. This is because government spending is a component of GDP itself.
Taxes and Transfers: changes in C + changes in I
Indirect Impact: Changes in taxes and transfers affect households’ disposable income, which in turn influences their consumption spending.
How fiscal policies can close recession gaps but cause higher price levels
Increased government spending: This directly boosts aggregate demand, stimulating economic activity and creating jobs.
Tax cuts: Lower taxes increase disposable income, leading to increased consumer spending and business investment
cause higher price levels:
-increase demand
-resource constraints
-wage-price spiral
That Keynesian economics suggest that costs and prices are “sticky,”
“sticky” = which means that the economy will not self-correct in the short-run.
Therefore governments should play an active role
in changing the spending in the economy – “spending against the wind” – to close both
the recessionary and expansionary output gap
MPC is the Marginal Propensity to Consume. MPC can be between 1 and 0. A larger value
means that more of your EXTRA income is spent
MPC: the % of extra income that is spent by households
The spending multiplier:
1/(1-MPC)
How to compute and explain the (Government) income-expenditure multiplier, its
relationships to MPC, and be able to compute the overall change in spending with a given
change in G
Suppose the MPC is 0.8 and the government increases spending by $100 billion.
Calculate the Multiplier:
Multiplier = 1 / (1 - 0.8) = 5
Calculate the Change in Total Spending:
Change in Total Spending = 5 × $100 billion = $500 billion
How to compute and explain the tax multiplier, and why government spending (G) is said to
have a bigger multiplying effect than tax cuts
When a gov. changes taxes and/or transfers; households/firms will change both the spending & their savings
Tax Multiplier = MPC / (1 - MPC)
If the MPC is 0.8, the tax multiplier is:
Tax Multiplier = -0.8 / (1 - 0.8) = -4
have a bigger multiplying effect than tax cuts: some tax changes will impact savings instead of spending
The three types of lags involved in fiscal policy (information, formulation, implementation)
Information: understanding what the current economic situation is
Formulation: the process of deciding on and passing legislation
Implementation: The time it takes for the policy to affect the economy
What automatic stabilizers are and how they help the economy reduced the size of gaps
taxes and government spending that affect fiscal policy without specific action from policy-makers
That the fundamental problem with fiscal policy is its impact on national debt
When governments increase spending or cut taxes to stimulate the economy, they often incur deficits, which can lead to a growing national debt.
The relationship between the deficit in a year (a flow value) and the overall or accumulated
national debt (a stock value)
Deficit spending can lead to increased national debt, which has potential long-term costs.
