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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
= AfterTax 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 rightPositive AD Shocks
Qualitatively G, TX, t, TR shift AD
to the leftNegative 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.
 Fall '08
 Maccini
 Macroeconomics

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