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Lecture 10

ECON 101 Lecture 10: Ch10

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San Diego State University
ECON 101

Chapter 10 Notes Federal budget - Can be split into 2 distinct types of spending: o Discretionary spending o Mandatory spending Discretionary spending - Decided through the appropriations process of Congress - Includes: national defense, transportation, science, environment, income security (some welfare programs like Medicaid), education, and veteran benefits and services Mandatory spending - Authorized by permanent laws - Does not go through the same appropriation process - Congress must vote to change entitlements - Includes: Social Security, Medicare, Medicaid, SNAP, TANF, and interest on the national debt Discretionary fiscal policy & aggregate demand - Discretionary fiscal policy: o Main goal: increase AD ▪ Move economy to full employment ▪ Encourage economic growth ▪ Control inflation o Adjusts government spending o Adjusts tax policies The multiplier effect - When government spending is injected into the economy, the total level of economic activity will expand by an amount equal to the size of the new expenditure times the multiplier - Because short-run aggregate supply is upward-sloping, some of the increase in output is absorbed by rising prices K = 1/(1 – MPC) = 1/MPS MPC + MPS = 1 Multiplier does not equal multiplier effect - When government spending shifts aggregate demand to the right, the equilibrium level of output will increase along with the price level Taxes GDP = C + I + G + (X – M) GDP = C + I Y = C +I Y – C = I S = I - Adding: government spending, taxes & the foreign sector o I + G + X = S + T + M - When taxes are increased, money is withdrawn from the economy’s spending stream - When taxes are reduced, consumers and business have more to spend - A tax increase (or decrease) will have less of a direct impact on income, employment, and output than will an equivalent change in government spending Expansionary fiscal policy - Expansionary fiscal policy can be used to shift aggregate demand to the right and close a recessionary gap o Employment and prices will increase as aggregate output expands Contractionary fiscal policy - When an economy moves beyond full employment, an inflationary spiral has set in - One way to reduce inflationary pressures is by a contractionary fiscal policy - This can be accomplished through: o Reducing government spending or transfer payments o Raising taxes Checkpoint: - Contractionary fiscal policy involves decreasing govt. spending, decreasing transfer payments, or increasing taxes - Politicians tend to favor expansionary fiscal policy because it brings increases in employment Supply-side fiscal policies - Main goal: LRAS  (shift to the right) - No trade-offs between price levels and outputs - Require more time to see the resul
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