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PART 3 Fiscal Policy - Chapter 12 (Pages 251 – 258) • Fiscal policy o Focuses on the effects of taxing and public spending on aggregate economic activity o Refers to gov’t purchases, transfer payments taxes, and borrowing as they affect macroeconomic variables such as real GDP, employment, the price level, and economic growth • Theory of Fiscal Policy o Fiscal Policy Tools  Automatic stabilizers – structural features of gov’t spending and taxation that reduce fluctuations in disposable income, and thus consumption, over the business cycle • Ex: Federal income tax o Once adopted, requires no congressional action to operate year after year (automatic) o Reduces the drop in disposable income during recessions and reduces the jump in disposable income during expansions (stabilizer)  Discretionary fiscal policy – the deliberate manipulation of gov’t purchases, taxation, and transfer payments to promote macroeconomic goals, such as full employment, price stability, and economic growth • Ex: Bush’s tax cuts o Scheduled to expire, so it remains discretionary fiscal policy measures unless they are made permanent  At any given price level, an increase in gov’t purchases or in transfer payments increases real GDP demanded, and an increase in net taxes decreases real GDP demanded, other things constant o Changes in Government Purchases  Gov’t purchases equal net taxes SO the gov’t budget is balanced  Unemployment high  gov’t purchases increase  quick increase in real GDP  spending exceeds output  increase in production  increase in income  increase in spending  so it all goes through a series of spending rounds  As long as consumption is the only spending component that varies with income, the multiplier for a change in gov’t purchases, other things constant, equals 1/(1-MPC)  For a given price level… • Change in real GDP demanded = Change in gov’t purchases x 1/(1-MPC) o Changes in Net Taxes  A decrease in net taxes increases disposable income at each level of real GDP….so consumption increases  We assume net taxes are autonomous  Consumption spending at each level of real GDP rises by the decrease in net taxes multiplied by the marginal propensity to consume  Effect of a change in net taxes on real GDP demanded equals resulting shift of the AE line times the simple spending multiplier: • Change in real GDP demanded = (-MPC x change in NT) x 1/(1-MPC)  Simple spending multiplier is applied to the shift of the AE line that results from the change in NT • Change in real GDP demanded = Change in NT x –MPC/(1 – MPC)  Simple Tax Multiplier – the ratio of a change in real GDP demanded to the initial change in autonomous
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