October 11 slides part 2

October 11 slides part 2 - Model Y E E CIG C C - bTX I I G...

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Unformatted text preview: Model Y E E CIG C C - bTX I I G G bTR b(1- t )Y Assumptions • Closed Economy • Completely Slack Conditions: Flat AS Curve • No Wealth Effects on Consumption Expenditure Schedule E CIG C - bTX bTR b(1- t )Y C - bTX bTR I G b(1- t ) Y Effective Intercept IG Slope Graph: Expenditure Schedule Market Equilibrium Fiscal Instruments • Tools of Fiscal Policy—What the government controls • Fiscal Instruments: G, TX , TR, t • NB: Government does not control tax revenue TX TX tY <---Government does not control tY because that varies with level of income. Examples of Fiscal Policies • $30 billion increase in military spending G G $30 bill • $30 billion increase in Social Security Benefits TR TR $30 bill • $30 billion tax cut in autonomous taxes: e.g., $500 per child tax credit (independent of Y) TX TX $30 bill Other Examples of Fiscal Policies • Reduction in the Marginal Tax Rate • Done in Section Meeting Increase in Military Spending: G A T ax C ut: TX Increase in Social Security Benefits: TR Qualitative Principle Qualitatively G, TR, TX , or t all Y. Called Expansionary Fiscal Policies <-- Raise E G, TR, TX , or t all Y. Called Contractionary Fiscal Policies <-- Lower E Quantitative Effects Changes in G directly affect E Changes in TX or t or TR only indirectly affect E by affecting Ydis and thus C Gives rise to important quantitative differences Example $30 bill G Assume MPC $30 bill $30 bill 2 3 TR, not TX TX $20 bill E $30 bill C Ydis $20 bill E DECLINE in Ydis, C, and E NOT an increase Quantitative Principle G has a larger quantitative effect on E and thus Y than an equivalent TR, TX , or t Reason: MPC 1 Similarly G has a larger quantitative effect on E and thus Y than an equivalent TR, TX , or t A pplication: G TR Model Y E E CIG C C b[Y TX I I G G tY TR ] Solution for the Equilibrium level of Real Income Equilibrium Schedule: Y E Expenditure Schedule: E C b[Y TX tY TR] I G b(1 t )Y C bTX bTR I G Substituting the Expenditure Schedule into the Equilibrium Schedule: Y b(1 t )Y C bTX bTR I G Moving Y to the LHS and factoring yields : What happened to previous Y?--> [1 b(1 t )]Y [C bTX bTR I G ] * Solving for the Equilibrium level of Real Income, Y : 1 * [C bTX bTR I G ] Y 1 b(1 t ) Multiplier: Autonomous Investment Suppose I rises to I , then Y ** Y 1 [C - bTX 1- b(1- t ) ** Y -Y Y I * bTR I G ] 1 1 [I - I ] I 1 - b(1- t ) 1- b(1- t ) 1 <---Multiplier 1 - b(1- t ) A Definition b(1 t ) Effective MPC = After-Tax MPC b(1 t ) b Income, Taxation & Disposable Income Ydis Y T TR Assume: Tx TX tY TR TR Then, Ydis Y TX tY TR (1 t )Y TX TR Effects on Consumption Ydis (1 t )Y TX TR Ydis C (1 t ) Y C bYdis C b Ydis b(1 t ) Y -If income goes up by a dollar, Ydis does not go up by a dollar as some of it is being paid in taxes to the government. How much it goes up by is dependent on the income tax percentage Effects of Income Taxation Principle: Income Taxation reduces the Size of Multipliers With Income Taxation: No Income Taxation: 1 1 b bt 1 Y I Y I 1 1 b(1 t ) 1 1 b bt 1 1b Reduces amount of consumption 1b Income Taxation is an "Automatic Stabilizer" "Automatic Stabilizer" because reduces size of multiplier. So when economy is hit by undesirable shock, it tends to reduce bad effect. Good thing when hit by negative demand shock. Fiscal Policy Multipliers Government Expenditure Multiplier: Y G Autonomous Tax Multiplier: Y TX Transfer Payment Multiplier: Y TR Marginal Tax Rate Multiplier: Y t 1 1 b(1 t ) b 1 b(1 t ) b 1 b(1 t ) bY * 1 b(1 t ) Fiscal Policy Multipliers Quantitative Effects Y G Y TR Y TX Y Y* t Reasons: G adds directly to E TR , MPC TX , or a b1 t adds indirectly to E Modified Consumption Function Add Wealth Effects on Consumption C C C bYdis A0 P A0 P C b 1 t Y TX +TR C bTX bTR Effective Intercept A0 P b(1 t ) Y Slope Model Wealth Effects on Consumption Y E E CIG C C b[Y TX I I G G tY TR ] A0 P New Aggregate Demand Curve Yd D ( P, C , I , G , TX , t , TR , A0 ) Fiscal Instruments Derivation of the slope is exactly the same Fiscal Instruments determine the position of AD ^ ^What the government controls. Effects of Fiscal Instruments on AD Qualitative Effects Fiscal Instruments are AD Shocks Qualitatively G, TX, t, TR shift AD to the right--Positive AD Shocks Qualitatively G, TX, t, TR shift AD to the left--Negative AD Shocks Shifts of AD to the Right Positive AD Shocks Raise aggregate planned spending so shift AD right Shifts of AD to the Left Negative AD Shocks Decrease aggregate planned spending. Quantitative Effects Quantitatively, G implies a larger shift of AD than an equivalent (same $ magnitude) TX , t , or TR and, similarly, Quantitatively, G implies a larger shift of AD than an equivalent (same $ magnitude) TX , t , or TR Effects of Fiscal Instruments on AD Quantitative Effects: Positive AD Shocks Effects of Fiscal Instruments on AD Quantitative Effects: Negative AD Shocks Effect on the Economy Expansionary Fiscal Policies Effect on the Economy Contractionary Fiscal Policies Fiscal Policy Principle Expansionary Fiscal Policies: cause both P & Y to Increase G, TX, t, or an TR Contractionary Fiscal Policies: G, TX, t, or a TR cause both P & Y to Decline ...
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This note was uploaded on 01/20/2012 for the course ECON 180.101 taught by Professor Maccini during the Fall '08 term at Johns Hopkins.

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