Lecture 18 Flashcards
Recessionary gaps
Recessionary Gaps: is when the actual level of real Gross Domestic Product (GDP) in an economy is below its potential GDP.
Fiscal policy what is it called whnen it shift aggregate demand
fiscal policy was expansionary, designed to shi the aggregate demand curve out; fiscal policies that shi the aggregate demand curve in are contractionary.
What can increase GDP, during. recession (Fiscal)
GDP Potienal ouput>GDP
At the initial short-run macroeconomic equilibrium, aggregate output is below potential output, What the government would like to do is increase aggregate demand, shifting
the aggregate demand curve rightward to This would increase aggregate output, making it equal to potential output. Fiscal policy that increases aggregate demand, called expansionary fiscal policy, normally takes one of three forms:
Expansionary fiscal policy is fiscal policy that increases aggregate demand.
1) Increased spednign
2) Cut taxes
3) Increase in goveremnt transfers
What is it called when GDP potienal output is greater than GDP and what is it called when GDP ouput < gdp
and how does the govrenemnt react in terms of fiscal policy?
It is called a recessionary gap whe gdp <Potienal ouput
It is called an infltionary gap when Gdp>potienal out
during a recssionary gap the govemrent will create exaposinary fiscal policy which is to icnrease aggregate demand to make gdp = potienal ouput
during a recessionary gap the government will introduce a contractionary fiscal policy to reduce aggregate demand to make gdp = potieinal output
GDP > Potienal ouput fiscal policy
during a recessionary gap the government will introduce a contractionary fiscal policy to reduce aggregate demand to make gdp = potieinal output
ways
1) Reduce goverment spedning
2) increase taxes
3) reducaiton in goverment transfers
Automatic stabilizer: and Discretionary fiscal policy
Automatic stabilizers are government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands.
The automatic decrease in government tax revenue generated by a fall in real GDP- caused by a decrease in the amount of taxes households pay—acts like an automatic expansionary fiscal policy implemented in the face of a recession
. Similarly, when the economy expands, the government finds itself automatically pursuing a contractionary fiscal policy—a tax increase
overnment spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands, without requiring any deliberate action by policy makers, are called automatic stabilizers.
Discretionary fiscal policy is the direct result of deliberate actions by policy makers rather than automatic adjustment.
- The government funds many programs through tax revenues:
- Governments transfers: payments by the government to households for which no good or service is provided in return
- Social insurance programs: goveremnt programs (transfer payents) protect recipients against hardship
- Fiscal policy: the use of taxes, government transfers, or government transfers, or goveremtn purchases of goods and services to shift the aggregate demand curve
- The government directly controls G and indreictly affects C and I
- How?
- Houesholds incomes are affected by taxes and transfers , and business investments is affected by taxes and regulations
- So the government can shift the AD Curve
Lags in fiscal policy:
Lags in fiscal policy: in the case of fiscal policy, there is an important reason for caution: There are significant lags in its use.
- It takes time to:
1. Realize the recessionary or finlationary gap by collecting and analyzing economic data
2. Develop a plan
3. Implmenet the action plan (spending the money)
fiscal multiplier
easures the impact of a change in government spending or taxation on a country’s overall economic output or Gross Domestic Product (GDP). I
Positive Fiscal Multiplier:
When the fiscal multiplier is positive, it indicates that a change in government spending or taxation leads to a larger change in GDP
Negative Fiscal Multiplier:
Conversely, when the fiscal multiplier is negative, it suggests that a change in government spending or taxation leads to a decrease in GDP that is greater than the initial change. I
Marginal propensity to consumer (MPC):
- Marginal propensity to consumer (MPC): The proportion of marginal income that a person consumes (as opposed to saves)
The marginal propensity to consume, or MPC, is the increase in consumer spending when disposable income rises by $1.
so how muhc more do consumers spend if you icnrease their income by 1$
If consumer spending goes up by $5 billion when disposable income goes up by $10 billion. then it would be 5/10=0.5 which mens every dollar you give 0.5 will be spent
MPC is a fundamental concept in Keynesian economics and plays a crucial role in understanding the relationship between changes in income and changes in consumption. It is often used to analyze the effects of fiscal policies, such as tax cuts or government transfers, on aggregate demand and economic growt’’’
MPC = Change in consumer spending / Change in disposable income
The MPC can range between 0 and 1. An MPC of 0 indicates that individuals save all additional income and do not increase their consumption, while an MPC of 1 suggests that individuals spend all additional income and do not save any of it.
The multiplier effect is based on the idea that when individuals receive additional income and spend a portion of it (determined by the MPC), it leads to an increase in overall income as the money circulates through the economy.
GDP Multiplier. Multiplier effects of an increase in government purchases of goods and servies
how to calculate MPC
Government spending we need to see how much a given policy will shi the aggregate demand curve. To get these estimates, they use the concept of the multiplier. Specifically MPC which is the proportion of an increase in income that gets spent on consumption.
MPC is the a
- Recall that (if we assume a simple case with not axes or international trade),
The multiplier is 1/(1-MPC)
Example if MPC = 0.5, the multipler would be
1/(1-0.5) = 2
So 50 billlion of new government spending would create 50*2=100 billion increase in real gdp
Consider the difference in the government, first/second and third round
A) 50 billion rise in government purchases of goods and service
B) $50 billion rise in government transfer payments
when MPC = 0.5
what is the multiplier for each?
B)
If MPC = 0.5 then in the first round B) would be = 50*0.5=25Billion and A would be 50 billion
Secon round would be 0.5(25) = 12.25
12.25)0.5=6.25
so addding all of it together would be 50Billion dollar total effect
while in government revenue:
first round 50 billion (they buy 50 billin dollar worth of goods ansd servies)
with that money cnsumers only spend 0.5 50=25,350.25=12.5
in total it would be 100 Billion
Total effect in terms of multiplier: Change in government spending *1/(1-MPC)
In Table 17-1, with an MPC equal to 0.5, the multiplier is exactly 1: a $50 billion rise in transfer payments increases real GDP by $50 billion. If the MPC is less than 0.5,
MPC multiplier formula for fiscal policy when government purchase goods and services vs when they transfer payments
When they purchase
Change in Y = Change in Government spending * 1/(1-MPC)
When they transfer money:
Change in revenue * MPC*1/(1-MPC)
So if MPC = 0.5 and you gave each 50 billion
The multiplier efect for Purchasing would be
Y=50*(1/0.5)=100 Billion
Multilier effect for transfering would be
Y=500.5(1/0.5)=50 Billion
What happens to government revenue when real gdp rises
when real GDP rises because the amount each individual owes in taxes depends positively on his or her income, and householdsʼ taxable income rises when real GDP rises. Sales tax receipts increase when real GDP rises because people with more income spend more on goods and services.
