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Chapter 11

Chapter 11

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Department
Economics
Course Code
ECN 204
Professor
Amy Peng

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Chapter 11
Fiscal policy and the AD-AS model
*fiscal policy: changes in government spending and tax collections designed to
achieve a full-employment and non-inflationary domestic output.
Expansionary fiscal policy
oExpansionary fiscal policy: an increase in government spending, a
decrease in net taxes, or some combination of the two, for the purpose
of increasing aggregate demand and expanding real output;
oBudget deficit: the amount by which the expenditures of the federal
government exceed its revenues in any year
oThree main options:
(1) increased government spending: Increase in government
spending will shift an economy’s aggregate demand curve tot the
right.
Through the multiplier effect, the AD shifts to the right,
because the multiplier process magnifies the initial
change in spending into successive rounds of new
consumption spending
oThe aggregate demand curve shifts the original
investment rightward times the multiplier
(2)Tax reduction
Reduce taxes shift AD to the right
The smaller the the MPC the greater the tax must be to
accomplish a specific initial increase in consumption.
(3)combined government spending increases and tax reductions
Rightward shifts of AD increase of aggregate
expenditures
Contractionary fiscal policy
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Description
Chapter 11 Fiscal policy and the AD-AS model *fiscal policy: changes in government spending and tax collections designed to achieve a full-employment and non-inflationary domestic output. • Expansionary fiscal policy o Expansionary fiscal policy: an increase in government spending, a decrease in net taxes, or some combination of the two, for the purpose of increasing aggregate demand and expanding real output; o Budget deficit: the amount by which the expenditures of the federal government exceed its revenues in any year o Three main options: (1) increased government spending: Increase in government spending will shift an economy’s aggregate demand curve tot the right. • Through the multiplier effect, the AD shifts to the right, because the multiplier process magnifies the initial change in spending into successive rounds of new consumption spending o The aggregate demand curve shifts the original investment rightward times the multiplier (2)Tax reduction • Reduce taxes shift AD to the right • The smaller the the MPC the greater the tax must be to accomplish a specific initial increase in consumption. (3)combined government spending increases and tax reductions • Rightward shifts of AD increase of aggregate expenditures • Contractionary fiscal policy www.notesolution.com o Contractionary fiscal policy: a decrease in government spending, and increase in net taxes, or some combination of the two for the purpose of decreasing aggregate demand and thus controlling inflation o Budget surplus: the amount by which the revenues of the federal government exceed its expenditures in any year o Three main options: (1)Decreased government spending • Reduced government spending shifts the AD to the left. • Ratchet effect: the price is stuck at the now increased priced that was caused by the original rightward shift in AD • ^ to fix this problem: o Take into account the size of the inflationary GDP gap. o Price level is fixed, aggregate supply will be horizontal, multiplier is in full effect o Decline the spending enough for the multiplier to be used to rid of the gap. (2)Tax Increases: use tax increases to reduce consumption spending.
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