Lesson_08_-_Chap_13-14 -...

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Lesson 8 Lesson 8 Fiscal Policy In this unit, you will expand your understanding of aggregate demand. One of the immediate consequences of this extension of the model of aggregate demand is that you will be able to understand an important class of macroeconomic polices called fiscal policies. The term fiscal policies refers to changes in the levels of government spending and/or taxes that are designed to shift the aggregate demand curve for the purpose of changing output or th price level. In addition, you will learn about the fiscal issues of deficits and debt. What will we learn in this lesson? When you are done with this lesson, you should be able to: Use the model of aggregate demand to understand the workings of fiscal policy. 1. Understand and explain the economy's built-in stabilizers. 2. Understand the limitations and difficulties of employing fiscal policy in practice. 3. Understand deficits, surpluses, and debt. 4. Understand the major "issues" of debts. 5. Understand the relationship between trade and government debts. 6. See how the government can reduce the debt. 7. Questions? If you have any questions, please post them to our I Don't Understand discussion forum (not e-mail), located under the Communicate or the Lesson tab in ANGEL. Your instructor will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you are able to help out another student. Lesson 8 Fiscal Policy Fiscal policy refers to government management of aggregate demand through changes in government spending and personal taxes. The tools that we hav developed allow us to see how fiscal policy works. You know from the aggregate supply and demand analysis of Unit 5 that if the economy is operatin at a level of output that is below the full-employment level of output, that an increase in demand will cause the level of output to increase. There are tw ways that the government can increase aggregate demand in this situation. One is to increase the level of government spending, as in the figure above. We learned in the last unit that the multiplier effect would increase GDP by a larger amount. The other is to reduce taxes. Be careful here. There is a multiplier effect as well, but because a decrease in taxes increases disposable income and therefore consumption spending, this (tax) multiplier is somewhat different . Because this multiplier process works through disposable income, aggregate demand will increase (shift to the right) by: Note this multiplier formula is very similar to the previous one. Also note, regardless of the MPC (or MPS), the tax multiplier is always one less than the ?regular? autonomous spending multiplier. Finally, you should see that taxes have an indirect affect on AD. Specifically, if taxes rise, then AD will fall. Furthermore, increases in government spending and /or decreases in taxes are called
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This note was uploaded on 10/08/2010 for the course ECON 002 taught by Professor Mcleod,markpehlivan,ayseozg during the Summer '08 term at Penn State.

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Lesson_08_-_Chap_13-14 -...

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