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CHAPTER 24 The Government and Fiscal Policy
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Principles of Economics,
9e
; ;
By
Karl E. Case,
Ray C. Fair &
Sharon M. Oster
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CHAPTER 24 The Government and Fiscal Policy
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PART V THE CORE OF MACROECONOMIC THEORY
24
The Government
and Fiscal Policy
Prepared by:
Fernando & Yvonn Quijano
© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster
PART V THE CORE OF MACROECONOMIC THEORY
The Government
and Fiscal Policy
24
CHAPTER OUTLINE
Government in the Economy
CHAPTER 24 The Government and Fiscal Policy
Government Purchases (G), Net Taxes (T),
and Disposable income (Yd)
The Determination of Equilibrium Output
(Income)
Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
The Tax Multiplier
The Balanced-Budget Multiplier
The Federal Budget
The Budget in 2007
Fiscal Policy Since 1993: The Clinton and
Bush Administrations
The Federal Government Debt
The Economy’s Influence on the
Government Budget
Tax Revenues Depend on the State of the
Economy
Some Government Expenditures Depend on the
State of the Economy
Automatic Stabilizers
Fiscal Drag
Full-Employment Budget
Looking Ahead
Appendix A: Deriving the Fiscal Policy
Multipliers
Appendix B: The Case in Which Tax Revenues
Depend on Income
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CHAPTER 24 The Government and Fiscal Policy
The multiplier applies to both external and
internal variables that influence the economy.
External changes include wars, the weather, and
OPEC oil price changes. Some examples of
internal variables that affect the economy via the
multiplier are government spending, taxes, and
investment.
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CHAPTER 24 The Government and Fiscal Policy
There is much controversy over the appropriate role
government should play in the economy. This controversy
constantly shifts between positive and normative
arguments.
1.Keynesians believe that the macroeconomy is likely to
fluctuate too much if left on its own
2.Others (known by various names but whose antecedents
are the classical school) claim that fiscal and monetary
policies are incapable of stabilizing the economy and, even
worse, may be destabilizing and harmful.
3.Most agree, however, that governments are important
actors in the economies of virtually all countries, like it or
not.
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CHAPTER 24 The Government and Fiscal Policy
The Government and Fiscal Policy
Fiscal Policy is any action that affects the
government’s spending and taxing
policies. Fiscal policy includes changes in
government purchases of goods and
services (mainly labor services), taxes,
and/or transfer payments to households
with the objective of changing the
economy’s growth.
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CHAPTER 24 The Government and Fiscal Policy
Monetary policy is the behavior of the Federal
Reserve concerning the nation’s money supply.
Monetary policy is fundamentally changes in the
quantity of money in circulation with the objective
of changing the economy’s growth. Often monetary
policy uses an interest rate target.
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CHAPTER 24 The Government and Fiscal Policy
We need to distinguish between variables that the government
controls directly and those that are a consequence of government
decisions.
1.For example, the government controls tax rates, but tax revenues
are also affected by the state of the economy.
2.Similarly, government spending also depends both on
government decisions and on the state of the economy. When the
economy moves into a recession and unemployment rises,
government spends more on unemployment compensation.
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Government in the Economy
CHAPTER 24 The Government and Fiscal Policy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
Net taxes (T) is taxes paid by firms and households to the
government minus transfer payments made to households by the
government. Net taxes equals tax revenue less transfer payments.
disposable, or after-tax, income (Yd) Total
income minus net taxes: Y - T.
disposable income ≡ total income − net taxes
Yd ≡ Y − T
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CHAPTER 24 The Government and Fiscal Policy
The government finances its expenditures by taxing
(and borrowing). When a fixed sum of money is
collected by the government as taxes, regardless of
the level of output in the economy.
In this case, DI is no longer equal to GDP. However,
the relationship between the two terms is very direct:
DI + T = GDP
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 24 The Government and Fiscal Policy
 FIGURE 24.1 Adding Net
Taxes (T) and Government
Purchases (G) to the
Circular Flow of Income
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 24 The Government and Fiscal Policy
When government enters the picture, the
aggregate income identity gets cut into three
pieces:
Yd  Y  T
Yd  C  S
Y  T  C S
Y  C S  T
And aggregate expenditure (AE) equals:
AE  C  I  G
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Government in the Economy
CHAPTER 24 The Government and Fiscal Policy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
budget deficit The difference between what a
government spends and what it collects in taxes in a
given period: G - T.
In 2008, the United States, Japan, the United
Kingdom, France, and Italy had budget deficits.
Canada had a small budget surplus. As a
fraction of GDP, the U.S. deficit was about 4
percent and Japan’s deficit was about 3 percent.
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 24 The Government and Fiscal Policy
Adding Taxes to the Consumption Function
1-Consumption spending now depends on disposable personal
income rather than on personal (before-tax) income: C = a + bYd.
2-The slope of the consumption function depends on both the
MPC and the tax rate.
C = a + bYd
or
C = a + b(Y − T)
Our consumption function now has consumption
depending on disposable income instead of
before-tax income.
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
CHAPTER 24 The Government and Fiscal Policy
Planned Investment
The government can affect investment behavior
through its tax treatment of depreciation and other
tax policies.
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Government in the Economy
The Determination of Equilibrium Output (Income)
Y=C+I+G
CHAPTER 24 The Government and Fiscal Policy
TABLE 24.1 Finding Equilibrium for I = 100, G = 100, and T = 100
(1)
Output
(Income)
Y
300
500
700
900
1,100
1,300
1,500
(2)
(3)
(4)
(5)
Net
Disposable
Consumption
Saving
Taxes
Income
Spending
S
T
Yd / Y  T (C = 100 + .75 Yd) (Yd – C)
100
100
100
100
100
100
100
200
400
600
800
1,000
1,200
1,400
250
400
550
700
850
1,000
1,150
 50
0
50
100
150
200
250
(6)
(7)
Planned
Investment Government
Spending
Purchases
I
G
100
100
100
100
100
100
100
100
100
100
100
100
100
100
(8)
(9)
(10)
Planned
Aggregate
Expenditure
C+I+G
Unplanned
Inventory
Change
Y  (C + I + G)
Adjustment
to Disequilibrium
450
600
750
900
1,050
1,200
1,350
 150
 100
 50
0
+ 50
+ 100
+ 150
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Output8
Output8
Output8
Equilibrium
Output9
Output9
Output9
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Government in the Economy
The Determination of Equilibrium Output (Income)
CHAPTER 24 The Government and Fiscal Policy
 FIGURE 24.2 Finding Equilibrium
Output/Income Graphically
Because G and I are both fixed
at 100, the aggregate
expenditure function is the new
consumption function displaced
upward by I + G = 200.
Equilibrium occurs at Y = C + I +
G = 900.
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CHAPTER 24 The Government and Fiscal Policy
A change in G means the total spending line will
shift up or down. Total expenditure in the economy
now equals C + I + G. (The only remaining term to
be added is net exports.)
If total expenditure in the economy exceeds the
level of output, the economy will expand.
Alternatively, if C + I + G is less than the level of
output, the economy will contract.
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Government in the Economy
The Determination of Equilibrium Output (Income)
The Saving/Investment Approach to Equilibrium
CHAPTER 24 The Government and Fiscal Policy
saving/investment approach to equilibrium:
S+T=I+G
To derive this, we know that in equilibrium,
aggregate output (income) (Y) equals planned
aggregate expenditure (AE). By definition, AE
equals C + I + G; and by definition, Y equals
C + S + T. Therefore, at equilibrium
C+S+T=C+I+G
Subtracting C from both sides leaves:
S+T=I+G
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Fiscal Policy at Work: Multiplier Effects
At this point, we are assuming that the government
controls G and T. In this section, we will review
three multipliers:
CHAPTER 24 The Government and Fiscal Policy
Government spending multiplier
Tax multiplier
Balanced-budget multiplier
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CHAPTER 24 The Government and Fiscal Policy
Government spending multiplier
What happens if Gov’t decides to increase its
level of expenditure in light of the output
gap ( rising unemployment )?
Similar to increase in an autonomous
investment expenditure, the Gov’t
expenditure will also cause multiplier
effects in the economy and will increase
national output and employment.
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What we mean by Gov’t EX
CHAPTER 24 The Government and Fiscal Policy
There are tow principle measurements of Gov’t in the
economy, Gov’t Ex on current goods and services (
the G in national income account) & the total EX,
which equal G + Transfers.
These transfers do not enter the national income
identity because they do not represents EX on
goods & services produced in the circular flow of
income- they can be thought of as negative taxes
and income in the form of transfers to the old,
unemployed….. Figure 15.5
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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
government spending multiplier 
1
CHAPTER 24 The Government and Fiscal Policy
MPS
government spending multiplier The ratio of the
change in the equilibrium level of output to a
change in government spending.
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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
TABLE 24.2 Finding Equilibrium After a Government Spending Increase of 50 (G Has
Increased from 100 in Table 24.1 to 150 Here)
CHAPTER 24 The Government and Fiscal Policy
(1)
Output
(Income)
Y
(2)
(3)
(4)
(5)
Net
Disposable Consumption
Saving
Taxes
Income
Spending
S
T
Yd / Y  T (C = 100 + .75 Yd) (Yd – C)
(6)
(7)
Planned
Investment Government
Spending
Purchases
I
G
(8)
(9)
(10)
Planned
Unplanned
Aggregate
Inventory
Adjustment
Expenditure
Change
To
C + I + G Y  (C + I + G) Disequilibrium
300
100
200
250
 50
100
150
500
 200
Output8
500
100
400
400
0
100
150
650
 150
Output8
700
100
600
550
50
100
150
800
 100
Output8
900
100
800
700
100
100
150
950
 50
Output8
1,100
100
1,000
850
150
100
150
1,100
0
1,300
100
1,200
1,000
200
100
150
1,250
+ 50
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Equilibrium
Output9
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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
CHAPTER 24 The Government and Fiscal Policy
 FIGURE 24.3 The
Government
Spending Multiplier
Increasing government
spending by 50 shifts
the AE function up by
50. As Y rises in
response, additional
consumption is
generated. Overall, the
equilibrium level of Y
increases by 200, from
900 to 1,100.
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Fiscal Policy at Work: Multiplier Effects
The Tax Multiplier
CHAPTER 24 The Government and Fiscal Policy
tax multiplier The ratio of change in the
equilibrium level of output to a change in taxes.
 1 
 Y  (initial increase in aggregate expenditure)  

 MPS 
1 
MPC 


Y  (  T  MPC )  
  T  

 MPS 
 MPS 
tax multiplier  
 
MPC
MPS
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Fiscal Policy at Work: Multiplier Effects
CHAPTER 24 The Government and Fiscal Policy
The Balanced-Budget Multiplier
balanced-budget multiplier The ratio of change
in the equilibrium level of output to a change in
government spending where the change in
government spending is balanced by a change in
taxes so as not to create any deficit. The
balanced-budget multiplier is equal to 1: The
change in Y resulting from the change in G and
the equal change in T are exactly the same size as
the initial change in G or T.
balanced-budget multiplier  1
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Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
TABLE 24.3 Finding Equilibrium After a Balanced-Budget Increase in G and T of 200 Each
(Both G and T Have Increased from 100 in Table 24.1 to 300 Here)
CHAPTER 24 The Government and Fiscal Policy
(1)
Output
(Income)
Y
(2)
(3)
(4)
Net
Disposable
Consumption
Taxes
Income
Spending
T
Yd / Y  T (C = 100 + .75 Yd)
(5)
(6)
(7)
(8)
(9)
Planned
Investment
Spending
I
Government
Purchases
G
Planned
Aggregate
Expenditure
C+I+G
Unplanned
Inventory
Change
Y  (C + I + G)
Adjustment
To
Disequilibrium
500
300
200
250
100
300
650
 150
Output8
700
300
400
400
100
300
800
 100
Output8
900
300
600
550
100
300
950
 50
Output8
1,100
300
800
700
100
300
1,100
0
1,300
300
1,000
850
100
300
1,250
+ 50
Output9
1,500
300
1,200
1,000
100
300
1,400
+ 100
Output9
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Equilibrium
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Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
TABLE 24.4 Summary of Fiscal Policy Multipliers
CHAPTER 24 The Government and Fiscal Policy
Policy Stimulus
Multiplier
Government
spending
multiplier
Increase or decrease in the
level of government
purchases: ∆G
1
MPS
Tax multiplier
Increase or decrease in the
level of net taxes: ∆T
 MPC
MPS
Balanced-budget
multiplier
Simultaneous balanced-budget
increase or decrease in the
level of government purchases
and net taxes: ∆G = ∆T
Final Impact On
Equilibrium Y
G 
T 
1
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1
MPS
 MPC
MPS
G
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CHAPTER 24 The Government and Fiscal Policy
Foreign Trade Multiplier
In closed economy equity between leakages
S+T & injections I+G is a must for
equilibrium.
On an open economy, there are tow
important variables to be considered,
exports X & imports M,
Equilibrium in an open economy S+T+M =
I+G+X
Exports like investment, they represent
spending on domestic goods & services
by foreigners & so are a source of income
for domestic factors of income.
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CHAPTER 24 The Government and Fiscal Policy
Exports have a multiplier effect like investment, when
factors income increase, there will be two possible
leakages. A from the new income goes for MPS,
imports may also rise, both are leakages from
injected exports.
Hence the foreign trade multiplier( also called the
export multiplier)
Can be represented as kf=1/(s+m)
Kf= export multiplier
S= MPS
M= MPI
If MPS =0.2 & MPI = 0.2 then kf=1/(0.2+0.2) = 1/0.4=
2.5
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CHAPTER 24 The Government and Fiscal Policy
How large the expansionary effect on national
income will be from a given increase in
exports depends on the slope of the
savings-imports schedule. This slope,
obviously, depends on the MPS & MPI.
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CHAPTER 24 The Government and Fiscal Policy
The Role of Fiscal Policy
Government policies that
increase aggregate demand
are called expansionary
policies.
Government policies that
decrease aggregate demand
are called contractionary
policies.
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CHAPTER 24 The Government and Fiscal Policy
The Limits to Stabilization Policies
Both expansionary policies and
contractionary policies are examples of
stabilization polices, actions to move the
economy closer to full employment or
potential output.
Stabilization policy is difficult because there
are time lags between recognition and
response to changes in the economy, and
because we simply do not know enough
about all aspects of the economy.
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CHAPTER 24 The Government and Fiscal Policy
The Federal Budget
The federal budget—the actual document that
describes what the federal government
spends and how it pays for it—provides
the framework for fiscal policy.
In 2003, total federal spending approximately
was 19.9 percent of GDP, or $2.15 trillion.
Federal taxes were 16.5 percent of GDP.
The government runs its budget on a fiscal
year basis, from October 1 to September
30.
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Federal Spending
Table 10.1 Federal Spending for Fiscal Year 2003
Category
Outlays (billions) Percent of GDP
CHAPTER 24 The Government and Fiscal Policy
Total outlays
$2,158
19.9%
825
7.6
Defense
405
3.7
Non-Defense
420
3.9
1,179
10.9
Social Security
470
4.3
Medicare and Medicaid
535
4.9
Other programs
174
1.7
153
1.4
Discretionary spending
Entitlements and mandatory spending
Net interest
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CHAPTER 24 The Government and Fiscal Policy
Federal Spending
Discretionary spending constitutes all the
programs that Congress authorizes on an
annual basis, which are not automatically
funded by prior laws passed by Congress.
Entitlements and mandatory spending
constitutes all spending that Congress
authorized by prior laws. They are the
single largest component of the federal
budget.
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CHAPTER 24 The Government and Fiscal Policy
Federal Spending
Social security provides retirement payments
to retirees, as well as a host of other
benefits to widows and families of disabled
workers.
Medicare provides health care to all
individuals once they reach the age of 65.
Medicaid provides health care to the poor, in
conjunction with the states.
Some of these programs are means-tested.
That is, they are partly based on the
income of the recipient.
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Federal Revenues
Table 10.2 Sources of Federal Government Revenue, Fiscal
Year 2003
CHAPTER 24 The Government and Fiscal Policy
Category
Total revenue
Receipts
(billions)
$1,782
Percent of GDP
16.5%
Individual income taxes
794
7.3
Social insurance taxes
713
6.6
22
0.2
132
1.2
Excise taxes and customs duties
87
0.8
Miscellaneous receipts
34
0.3
Estate and gift taxes
Corporate income taxes
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CHAPTER 24 The Government and Fiscal Policy
Automatic Stabilizers
Taxes and transfer payments that stabilize
GDP without requiring explicit actions by
policymakers are called automatic
stabilizers.
During an economic boom, transfer payments
fall and taxes increase.
During a recession, running a government
budget deficit offsets part of the adverse
effect of the recession and thus helps
stabilize the economy.
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CHAPTER 24 The Government and Fiscal Policy
Concerns About Deficits
In the long run, large budget deficits can have
an adverse effect on the economy.
When the economy is at full employment, a cut
in household taxes will tend to increase
consumer spending. However, since output
is fixed at full employment, some other
component of output must be reduced, or
crowed out. This is an example of the
principle of opportunity cost.
PRINCIPLE of Opportunity Cost
The opportunity cost of something is what you
sacrifice to get it.
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The Federal Budget
CHAPTER 24 The Government and Fiscal Policy
federal budget The budget of the federal
government.
The “budget” is really three different budgets.
First, it is a political document that dispenses
favors to certain groups or regions and places
burdens on others.
Second, it is a reflection of goals the government
wants to achieve.
Third, the budget may be an embodiment of some
beliefs about how (if at all) the government should
manage the macroeconomy.
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The Federal Budget
CHAPTER 24 The Government and Fiscal Policy
The Budget in 2007
TABLE 24.5 Federal Government Receipts and Expenditures, 2007 (Billions of Dollars)
Amount
Percentage Of Total
Receipts
Personal income taxes
1,162.1
43.5
Excise taxes and customs duties
99.9
3.7
Corporate income taxes
380.8
14.3
Taxes from the rest of the world
13.4
0.5
Contributions for social insurance
953.0
35.7
Interest receipts and rents and royalties
25.1
0.9
Current transfer receipts from business and persons
39.4
1.5
Current surplus of government enterprises
− 2.3
− 0.0
Total
2,671.4
100.0
Current Expenditures
Consumption expenditures
856.0
29.6
Transfer payments to persons
1,270.7
43.9
Transfer payments to the rest of the world
38.6
1.3
Grants-in-aid to state and local governments
377.5
13.1
Interest payments
302.4
10.5
Subsidies
46.7
1.6
Total
2,892.0
100.0
Net federal government saving—surplus (+) or deficit (−)
− 220.6
(Total current receipts − Total current expenditures)
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
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The Federal Budget
The Budget in 2007
CHAPTER 24 The Government and Fiscal Policy
federal surplus (+) or deficit () Federal
government receipts minus expenditures.
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The Federal Budget
CHAPTER 24 The Government and Fiscal Policy
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 24.4 Federal Personal Income Taxes as a Percentage of Taxable Income, 1993 I–2007 IV
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The Federal Budget
CHAPTER 24 The Government and Fiscal Policy
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 24.5 Federal Government Consumption Expenditures as a Percentage of GDP and
Federal Transfer Payments and Grants-in-Aid as a Percentage of GDP, 1993 I–2007 IV
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The Federal Budget
CHAPTER 24 The Government and Fiscal Policy
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 24.6 The Federal Government Surplus (+) or Deficit (–) as a Percentage of GDP,
1993 I–2007 IV
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The Federal Budget
The Federal Government Debt
CHAPTER 24 The Government and Fiscal Policy
federal debt The total amount owed by the
federal government.
privately held federal debt The privately held
(non-government-owned) debt of the U.S.
government.
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The Federal Budget
CHAPTER 24 The Government and Fiscal Policy
The Federal Government Debt
 FIGURE 24.7 The Federal Government Debt as a Percentage of GDP, 1993 I–2007 IV
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The Economy’s Influence on the Government Budget
Tax Revenues Depend on the State of the Economy
CHAPTER 24 The Government and Fiscal Policy
Tax revenue, on the other hand, depends on
taxable income, and income depends on the state
of the economy, which the government does not
completely control.
Some Government Expenditures Depend on the State of the
Economy
Transfer payments tend to go down automatically
during an expansion.
Inflation often picks up when the economy is
expanding. This can lead the government to spend
more than it had planned to spend.
Any change in the interest rate changes
government interest payments.
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The Economy’s Influence on the Government Budget
Some Government Expenditures Depend on the State of the
Economy
CHAPTER 24 The Government and Fiscal Policy
Fiscal Policy In 2008
Congress Approves
Economic-Stimulus Bill
Wall Street Journal
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The Economy’s Influence on the Government Budget
Automatic Stabilizers
CHAPTER 24 The Government and Fiscal Policy
automatic stabilizers Revenue and expenditure
items in the federal budget that automatically
change with the state of the economy in such a
way as to stabilize GDP.
Fiscal Drag
fiscal drag The negative effect on the economy
that occurs when average tax rates increase
because taxpayers have moved into higher
income brackets during an expansion.
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The Economy’s Influence on the Government Budget
Full-Employment Budget
CHAPTER 24 The Government and Fiscal Policy
full-employment budget What the federal
budget would be if the economy were producing at
the full-employment level of output.
structural deficit The deficit that remains at full
employment.
cyclical deficit The deficit that occurs because of
a downturn in the business cycle.
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CHAPTER 24 The Government and Fiscal Policy
REVIEW TERMS AND CONCEPTS
automatic stabilizers
balanced-budget multiplier
budget deficit
cyclical deficit
discretionary fiscal policy
disposable, or after-tax,
income (Yd)
federal budget
federal debt
federal surplus (+) or deficit (−)
fiscal drag
fiscal policy
full-employment budget
government spending
multiplier
monetary policy
net taxes (T)
privately held federal debt
structural deficit
tax multiplier
1. Disposable income Yd ≡ Y − T
2. AE ≡ C + I + G
3. Government budget deficit ≡ G − T
4. Equilibrium in an economy with
government: Y = C + I + G
5. Saving/investment approach to
equilibrium in an economy with
government: S + T = I + G
1
6. Government spending multiplier ≡
MPS
 MPC 

 MPS 
7. Tax multiplier ≡  
8. Balanced-budget multiplier ≡ 1
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APPENDIX A
DERIVING THE FISCAL POLICY MULTIPLIERS
THE GOVERNMENT SPENDING AND TAX MULTIPLIERS
C  a  b(Y  T )
CHAPTER 24 The Government and Fiscal Policy
Y  C I  G
Y  a  b(Y  T )  I  G
Y  a  bY  bT  I  G
Y  bY  a  I  G  bT
Y (1  b)  a  I  G  bT
1
Y 
(a  I  G  bT )
1  b
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APPENDIX A
DERIVING THE FISCAL POLICY MULTIPLIERS
THE BALANCED-BUDGET MULTIPLIER
CHAPTER 24 The Government and Fiscal Policy
The balanced-budget multiplier is found by
combining the effects of government spending and
taxes:
increase in spending:
- decrease in spending:
= net increase in spending
G
C  T ( MPC )
G  T ( MPC )
In a balanced-budget increase, ΔG = ΔT; so we can
substitute:
net initial increase in spending:
ΔG − ΔG (MPC) = ΔG (1 − MPC)
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APPENDIX A
DERIVING THE FISCAL POLICY MULTIPLIERS
THE BALANCED-BUDGET MULTIPLIER
CHAPTER 24 The Government and Fiscal Policy
Because MPS = (1 − MPC), the net initial increase
in spending is:
ΔG (MPS)
 1 
We can now apply the expenditure multiplier 

MPS


to this net initial increase in spending:
 1 
Y  G ( MPS ) 
  G
 MPS 
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APPENDIX B
THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
CHAPTER 24 The Government and Fiscal Policy
 FIGURE 24B.1 The Tax Function
Yd  Y  T
Yd  Y  (200  1 / 3Y )
Yd  Y  200  1 / 3Y
C  100  .75Yd
C  100  .75(Y  200  1 / 3Y )
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APPENDIX B
THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
Y  C  I G
Y  100  .75(Y  200  1/ 3Y )  100  100
I
G
C
CHAPTER 24 The Government and Fiscal Policy
Y  100  .75Y  150  .25Y  100  100
Y  450  .5Y
.5Y  450
 FIGURE 24B.2 Different Tax
Systems
When taxes are strictly lump-sum (T =
100) and do not depend on income,
the aggregate expenditure function is
steeper than when taxes depend on
income.
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APPENDIX B
THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
THE GOVERNMENT SPENDING AND TAX MULTIPLIERS ALGEBRAICALLY
C  a  b(Y  T )
CHAPTER 24 The Government and Fiscal Policy
C  a  b(Y  T0  tY )
C  a  bY  bT0  btY
Y  a  bY  bT  btY  I  G
0
C
1
Y
(a  I  G  bT0 )
1  b  bt
1
1  b  bt
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