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Chapter 29

ECON 1010 Chapter 29: ECON1010 Notes - Chapter 29

Course Code
ECON 1010
Steven Edwards

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Federal Budget & Balancing
Federal budget – annual statement of federal government’s outlays and revenues
oRevenues – from personal income taxes (largest), corporate income taxes, indirect taxes, and
investment income
oOutlays – transfer payments (largest), expenditure on goods and services, and debt interest
Purpose: Finance activities of federal government & achieve macroeconomic objectives
oFiscal policy – use of federal budget to achieve macroeconomic objectives EG full employment,
sustained economic growth, and price level stability
Made by federal government and Parliament; Minister of Finance presents budget plan to
Parliament and after debate enacts laws to implement it
Budget balance = revenue – outlays
oIf revenue > outlays = budget surplus
oIf revenue < outlays = budget deficit
Government debt – total amount government borrowing; past deficits – past surpluses
Supply-Side Effects of Fiscal Policy
Supply-side effects – effects on employment, potential GDP, and aggregate supply from fiscal policy
oSupply-side effect of rise in income tax decreases potential GDP and AS
Income tax decreases labor supply because tax decreases after-tax wage rate and raises before-tax real
wage rate
oTax wedge – gap between before and after-tax wage rate
Taxes on consumption expenditure add to tax wedges; raises price paid for consumption
Tax on capital income lowers quantity of saving/investment; slows rate of real GDP growth
Real after-tax interest rate - interest rate that influence saving investment; = real interest -
income tax paid on interest income
Laffer curve - relationship between tax rate and amount of tax revenue collected
oFor tax rate below T* rise in tax rate increases tax revenue
oFor tax rate above T*, rise in tax rate decreases tax revenue
Fiscal Stimulus
Fiscal stimulus –use of fiscal policy to increase production and employment
Automatic fiscal policy – fiscal policy action triggered by state of economy with no government action
oTwo items in government budget change automatically in response to economy
Tax revenues- parliament set tax rates with revenues dependent on real GDP
When real GDP increases in expansion, tax revenues increase.
When real GDP decreases in recession, tax revenues decrease
oTransfer payments - government creates programs that pay benefits to qualified people/businesses;
dependent on economy
When economy is in expansion, unemployment falls, so unemployment benefits decrease
When economy is in recession, unemployment rises, so unemployment benefits increase
oIn recession, tax revenues decrease and outlays increase; budget provides automatic stimulus that
helps shrink recessionary gap.
oIn boom, tax revenues increase and outlays decrease; budget provides automatic restraint that helps
shrink inflationary gap.
oStructural surplus or deficit – budget balance that would occur if economy were at full employment
and real GDP = potential GDP
oCyclical surplus or deficit – actual surplus/deficit - structural surplus/deficit; occurs because real GDP
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