FISCALPOLICY

FISCALPOLICY - FISCAL POLICY FISCAL POLICY The manipulation...

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FISCAL POLICY FISCAL POLICY The manipulation of the federal budget to attain price stability, relatively full employment and a satisfactory rate of economic growth. To attain these goals, the government must manipulate its spending and taxes. Putting Fiscal Policy into Perspective Until the time of the Great Depression, the only advise economists gave the government was to try to balance its budget every year and not to interfere with the workings of the private economy. There was no such thing as fiscal policy until J.M Keynes invented it in the 1930s. Keynes pointed out – there was a depression going on – the problem was anemic (AD) a) C – was lagging because so many people were out of work b) I – was extremely low because there was no reason for business owners to add to their inventories or build more plant and equipment. c) After all, sales were very low and much plant and equipment were sitting idle. d) Since both C and I were low, the only thing left to boost AD was G What about taxes? Well, certainly, we would not want to raise them. Equilibrium GDP Tell us the level of spending in our economy Full Employment GDP Tell us the level of spending necessary to get our unemployment rate down to 5%, key, natural rate of unemployment. We would see how fiscal policy is used to push our equilibrium GDP toward full-employment GDP. Equilibrium GDP - Too big (much) spending – inflationary gap - Too little spending – Deflationary gap
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Some facts to note before approaching deflationary and inflationary gaps 1) Our economy is always or tending toward equilibrium GDP 2) Equilibrium GDP is the output level at which AD = AS 3) AD = C+I+G+Xn 4) AS = the nation’s total output of final goods and services = GDP 5) At equilibrium GDP, everything produced is sold 6) Full employment means nearly all our resources are being used a) plant and equipment are operating at b/w 85-90% of capacity b) only 5% of the labor force is unemployed 7) Full employment GDP is the level of spending necessary to provide full employment of our resources. THE DEFLATIONAY GAP A deflationary gap occurs when equilibrium GDP is less than full employment GDP Equilibrium GDP The level of spending that the economy is at or is tending toward Full Employment GDP The level of spending needed to provide enough jobs to reduce the unemployment rate to 5%. When too little is being spent to provide enough jobs, we have a deflationary gap. Deflationary Gap When we are producing inside the PPF GDP P AD AS Q E Q FE Deflationary gap
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Solutions: Raise spending – C, I, G or some combination Keynes proposed raising G or lowering T. Lower business taxes I↑; lower personal taxes C↑ Inflationary Gap The equilibrium GDP is to the right of full employment GDP. In other words, equilibrium GDP > full employment GDP. Solution (Keynes):
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FISCALPOLICY - FISCAL POLICY FISCAL POLICY The manipulation...

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