Download Ch. 12 Student Ppt

present by: Ivy, Yi Lin, Mamie, Mon,
Chris
you will:
1.
2.
3.
learn about expansionary and contractionary fiscal
policies, which are used by governments seeking
economic stability
analyze the multiplier effect of fiscal policy, as
determined by the marginal propensities to
consumer and withdraw
consider budget surpluses and deficits and their
impact on public debt and public debt charges
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Stabilization policy is government policy designed to
lessen the effects of the business cycle which can be
either expansionary policies or contractionary policies.
expansionary policies attempt to reduce unemployment and
stimulate total output
contractionary policies attempt to stabilize prices and bring the
economy back down to its potential output.
Real GDP
CONTRACTION
EXPANSION
Long-Run Trend
of Potential Output
Peak
With stabilization policy
Trough
Time
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Governments have an extensive impact on the
economy through texation and government
purchases.
Fiscal Policy uses taxes and government
purchases as its tools
 Fiscal Year is the 12-month period to which a
budget applies
 Monetary policy uses interest rates and the
money supply as its tool.
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Expansionary fiscal policy involves increasing
government purchases, decreasing taxes, or both
to stimulate spending and output.
 Contractionary fiscal policy involves decreasing
government purchases, increasing taxes, or both
to restrain spending and output.
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Price Level (GDP deflator,
1997 = 100)
AS
b
170
Initial
Recessionary
Gap
a
160
AD1
AD0
Potential Output
0
780
800
Real GDP (1997 $ billions)
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expansionary fiscal policy involves more government purchases
and/or lower taxes to shift AD rightward
Price Level (GDP deflator,
1997 = 100)
AS
d
190
Initial
Inflationary
Gap
c
170
AD0
Potential Output
AD1
800 810
0
Real GDP (1997 $ billions)
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contractionary fiscal policy involves fewer government
purchases and/or increased taxes to shift AD leftward
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Discretionary Policy is international government intervention
in the economy such as bedgeted changes in spending or
texation.
Automatic stabilizers: built-in measures, such as
texation&transfer payment programs, that lessen the effects of
the business cycle.
Net tax revenues = taxes collected —— transfers&subsidies
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The magnified impact of a spending change on aggregate
demand
an initial spending change produces income and part of
this new income becomes new spending
The process is repeated with each spending round smaller
than the last
Each new spending round are determined by the marginal
propensity to consumer(MPC) and marginal propensity
Marginal propensity to consumer (MPC)
the effect on domestic consumption of a change in income
MPC = change in consumption on domestic items
change in income
Marginal propensity to withdraw (MPW)
the effect on withdrawals—saving, imports, and taxes—of a change in
income
MPW = change in total withdrawals
change in income
*MPC + MPW = 1
income is always either spend or withdrawn
Exercise: A $100 increase in a person's income causes him to increase
his saving by $5, his imports by $35, and his tax payments by $20. In
this case, the marginal propensity to withdraw is:
Change in total withdrawals(saving/ import/ taxes)
Change in income
5 + 35 + 20 = 60 = 0.6
100
100
The multiplier effect will continue until withdrawals equal to the
initial discretionary injection
The spending multiplier is the value by which the initial
spending change is multiplied to give the total change in real
output.
In other words, the shift in the aggregate demand curve
Total change in output = initial change x
(shift in AD curve)
in spending
spending
multiplier
Example:
Find the spending multiplier when initial spend has rose by
$1000 and the total output increased by $2000.
Spending multiplier= total change in
output
Initial change in
spending
=$2000
$1000
=2
Relationship between the marginal propensity to
withdraw and the spending multiplier
The spending multiplier is the reciprocal of the
marginal propensity to withdraw.
Example:
If MPW (marginal propensity to withdraw) is 0.5 what is
the spending multiplier?
Spending Multiplier =__1__
MPW
=_1_
0.5
=2
Effect of a Tax Cut
The multiplier effect can be applied to tax cuts
Tax cuts can be used to expand the economy
Lower tax cuts can leave households and businesses with
more funds to spend and invest
The initial spending stimulus of the tax cut is multiplied by
the spending multiplier (or reciprocal of MPW). This results
in an increase in total output
a shift in the aggregate demand curve
The initial change in spending on domestic items from a
change in taxes (T) is found by multiplying the
economy’s marginal propensity to consume by the size
of the tax change, then it is multiplied by the spending
multiplier (1/MPA)
Total change in output = initial change x
spending
(shift in AD curve)
in spending
multiplier
Total change in output = - (MPC X change in T) x (1/MPA)
-(MPC X T) has a minus sign because the spending
change is in the opposite direction to the tax change
Relevance of the Spending Multiplier
When the economy is close to its potential level, the increase in
aggregate demand translates into higher price levels more than into
expanded production
When the stated goal being a stable economy and expanded output,
expansionary fiscal policy is less effective the closer the economy is to its
potential
Similarly, for the contractionary fiscal policy, when the economy is
above its potential, a decrease in aggregate demand means both price
level and total output will fall
Based on the possible changes in the price level, the multiplier effect is
less definite than the use of simple formula would indicate
Two benefits as stabilization tool:
regional focus and impact on spending
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Regional focus：（it can be focused on particular regions）
During a recession, new government purchases and program to reduce
the amount of tax paid can be targeted to regions where
unemployment rate are highest.（ Net income revenue drop hit by
unemployment and falling output.）
In a boom, spending cuts and tax hikes can be concentrated on the
regions where inflation is at its worst.（ Larger increase in net tax
revenue in regional where the economy is most over-heated.）
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Impact on spending
it has a relatively direct impact on spending
（compare with monetary policy--Fiscal policy is easy to control the
trend of economy, making it closer the potential output and achieve
the goal of stabilization)
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influences of a stabilization is tied to its initial effect on spending
During recession, government increase the government purchases, it
decrease the spending
In contrast, government decreases the government purchases which
increase the spending—alter the government purchases to make
economy stability.
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a)Delays while automatic stabilizers to stabilize the economy, the
discretionary measure are sometimes delayed.
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Recognition lag: the amount of time it takes policy-makers to realize that a
policy needed.( decided and realized the economy need adjusted )
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Decision lag: the amount of time needed to formulate and implement an
appropriate policy.(how to adjust)
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Impact lag: the amount of time between a policy’s implementation and its
having an effect on the economy.(already have move to a different point in
the business cycle )
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b)Political visibility
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Discretionary is highly visible element of government activity,
therefore, it is often affected by political and economic
considerations.
E.G vote: increases in government purchases and reduce the
taxes, regardless of the appropriateness of these policies for the
economy.(election is coming up)
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c)Public debt
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Public debt: the total amount owned by the federal government as a
result of its past borrowing.
Total government: include the debts of individuals’ provinces and
territories and incorporates local government and hospital.
Public debt charges: the amounts paid out each year by the federal
government to cover the interest charges on its public debt.
E.G. the federal government’s public charge were37.2billion, the
government should pay 507.7 to bondholders. What is the average
interest?
Average interest rate=public debt charge/public debt
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Balanced budget
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Balanced budget mean government’s
expenditures and revenues are equal
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This situation is so uncommon.
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Budget surplus is the government’s
revenues exceed its expenditures
government revenues- government expenditures =
Budget surplus
For example, government will cut defence spending
and raising income taxes during the economic
boom to suppress the inflationary.
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Budget deficit is the government’s
expenditures exceed its revenues
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government expenditure – government revenue=Budget
deficit
For example, government will increase the spending on
road and bridges, or institute a temporary sales-tax cut
to stimulate household spending, during the downturn.
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The government’s debt represents the sum
of all its past budget deficits minus any
budget surpluses.
Budget deficits- Budget surpluses= government’s debt
 When the government has a budget surplus, the the
public debt reduced by the same amount.
 When the government has a budget deficit, the public
debt increases by the same amount.
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There are 3 principles that guide government fiscal policy:
1）Annually balanced budgets
2）Cyclically balanced budgets
3）Functional Finance
 Critics of fiscal policy suggest that any fiscal policy that is used must
be guided by the principle of an annually balanced budget. In other
words, revenues and expenditures should be balanced every year.
 Critics also say that an annually balanced budget is not necessarily
appropriate for society and state it is flawed reasoning.
 Cyclically balanced budget is the principle that government revenues
and expenditures should balance over the course of one business
cycle.
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Functional Finance is the principle that government budgets should
be geared to the yearly needs of the economy.
The choice of fiscal policy guidelines depends on the government’s
belief in fiscal policy as an effective tool for stabilizing the economy.
Defenders of functional finance are those who see functional finance
as a powerful stabilizing tool, while economist who support cyclically
or annually balanced budget tend to be less convinced of fiscal
policy’s effectiveness.
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In the 1970s and early 1980s, Canada believed in functional finance
but recently had made unsuccessful attempts to move towards
cyclically balanced budgets.
This change in view came from constant budget deficits and their
impact on the economy as a whole.
Total government deficits were highest during the recessions in early
1980s and 1990s.
The 1980s deficits were largely optional, while the 1990s deficits were
related to automatic stabilizers.
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Neoclassical theory is the view of economy that economic slow-downs
such as the great depression were self correcting and is based on two
assumptions: flexible labour markets and Say’s law.
 Flexible labour markets: Neoclassical economists suggest that both the
demand and supply of labour depend on real wage rate, or wages
expressed in constant base-year dollars, rather than the nominal wage
rate, which is valued in current dollars.
 There are two types of unemployment:
1）Voluntary unemployment
2）Involuntary unemployment
 Voluntary unemployment exists whenever workers decide that real wages
are not high enough to make work worthwhile.
 Involuntary unemployment is when someone wants to work at the
current real wage rate but cannot find a job. Involuntary occurs when
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the market demand and supply creates a surplus.
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Say argued that supply automatically creates its own
demand.
An example would be a tailor supplies clothes in order to
have funds needed to purchase other products.
Keynes’s theory challenged both assumptions made by the
neoclassical economists. Keynes believed that workers are
influenced by nominal wages rather than real wages and
purchasing power.
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