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Chapter 12

ECO105Y1 Chapter 12: MACRO

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Chapter 12: Fiscal Policy, Deficits, and National Debt
12.1 Aggregate Demand Policies for Stabilizing Business Cycles
- Fiscal Policy: changes governments make to purchases, transfers, and taxes to achieve
macroeconomic goals
- Two paths to impact economy
- Government Purchases
- Injections into the circular flow
- Injection: spending in the circular flow that does not start with consumers
- Such as building highways, accounting firms
- Net Taxes
- Net taxes = Taxes received minus transfer payments
- Leakage: spending that leaves the circular flow through taxes, savings,
and imports
- Injections vs. Leakages
- Combine together often
- Example: Government spends $100M on new bridge
- “G” increases by $100M (Injection)
- Increased income for bridge business, which leaks to government as tax
- Some of income is saved, another leakage
- Some of money is spent on imports, another leakage
- Cycles (The Multiplier Effect)
- Assume 50% of the 100M is leaked, and 50% is spent in Canada
- 50M is invested back in, then 25, etc.
- Multiplier Effect: a spending injection has a multiplied effect on aggregate
- Also works in reverse
- Reduction in gov. Spending has multiplied reduction on A.
- Size of Multiplier Effect = 1 / % of leakages from additional income
- Estimated to be around 2 for gov. Spending
- A tax cut or an increase in transfer payments reduces leakages
- Consumers have more money to spend
- Same in opposite
- M.E less impactful in tax changes than gov. Spending because tax
cuts are often saved more income
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- Increase in gov. Spending shifts GDP rightward
- Other Injections
- Business investment is most volatile part of ag. Demand
- Since Canada is a trading nation (30% GDP from export sales), if
countries we trade with do poorly, so will we
- Fiscal Policy and Ag. Demand
- Two types
- Expansionary fiscal policy
- Increased ag. Demand by increasing gov. Spending, decreasing
taxes, shifts curve rightward (positive demand shock)
- Done in 2009 during Global Financial Crisis
- Contractionary fiscal policy
- Decreased ag. Demand by decreasing gov. Spending, increasing
taxes, shifts curve leftward (negative demand shock)
- Multiplier Effect and Real GDP
- The closer the economy is to potential GDP, the lower the impact
of the M.E
- Two Camps and Fiscal Policies
- Hands-Off
- Fiscal policy is necessary to accelerate economy
- Less tax to put money in hands of individuals
- To slow economy, gov. Should reduce spending to keep money in
individual’s pockets
- Hands-On
- Gov. spending to prevent people from saving money and slowing
down economy
- To slow economy, tax increases to stabilize economy and have
money re-invested intelligently
12.2 Aggregate Supply Policies from Promoting Growth
- Increases in ag. Supply produce economic growth
- Quality of inputs, technological change, productivity
- Living standards rise when GDP per person increases
- Increases in supply shift LRAS and SRAS to right
- Intersection of AD, LRAS, SRAS is now at a larger GDP and at a lower CPI
- Aggregate Supply Policies
- Stimulate Saving and Capital Investment
- Government uses tax incentives to stimulate saving and increase quantity
of capital available
- Tax exemptions for interest in TFSAs make it easier and cheaper for
business to borrow to finance new infrastructure
- Encourage Research and Development
- Government funds research organizations such as NSERC
- Improve Education and Training
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