○ Aggregate supply will decrease, which will decrease prices further ● Production possibilities and long-run aggregate supply ○ Economic growth is illustrated by either an outward shift on the production possibilities curve or a rightward shift in the long run aggregate supply curve ○ As the curves shift, they will lead to price increases at a new equilibrium level Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
48 Recessionary and inflationary gaps in the AD-AS model ● Ongoing inflation in the long-run AD-AS model ○ Modern economies tend to experience positive rates of inflation due to: ■ Economic growth causing rightward shifts of the AS curve ■ Central banks then cause rightward shifts of the AD curve so that it proceeds just a little faster than the deflationary rightward shifts of the AS curve ■ The net effect is (usually) a small positive rate of inflation ● Depicting Canadian growth in the long-run AD-AS model ○ To manage inflation, the Bank of Canada uses monetary policy to shift the aggregate demand curve to the right faster than the supply factors of economic growth shift the long-run aggregate supply curve to the right ● Long-run AD-AS model ○ Economic growth causes increases in long-run aggregate supply ○ Whether deflation, or inflation accompanies growth depends on the extent to which aggregate demand increases relative to aggregate supply ○ Any inflation that occurs is the result of growth of aggregate demand ○ It is not the result of the growth of real GDP Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
49 Fiscal Policy, Deficits, Surpluses, and Debt Discretionary fiscal policy: expansionary and contractionary ● Expansionary fiscal policy ○ Used when recession occurs ○ Options: ■ Increased government spending ■ Tax reductions ■ Combined government spending increases and tax reductions ■ May create a budget deficit ● Contractionary fiscal policy ○ Used to combat demand-pull inflation ○ Options: ■ Decreased government spending ■ Increased taxes ■ Combined government spending decreases and tax increases ● Policy options: G or T? ○ To expand the size of government ■ If recession, then increase government spending ■ If inflation, then increase taxes ○ To reduce the size of government ■ If recession, then decrease taxes ■ If inflation, then decrease government spending Downloaded by Ryan L. ([email protected]) lOMoARcPSD|4821790
50 Built in stabilizers ● Built-in stability ○ Net tax revenues vary directly with GDP ■ Taxes rise when GDP rises, and vice versa ■ Transfer payments fall when GDP rises, and vice versa ○ Leads to automatic stabilization over the business cycle ● Automatic or built-in stabilizers ○ A structure of taxation and spending that: ■ Increases the deficit (reduces the surplus) during recession ■ Increases the surplus (reduces the deficit) during inflation ● Economic importance ○ The stabilizers will automatically restrain economic expansion and cushion economic contraction ○ Taxes reduce spending and aggregate demand ○
- Winter '08
- Inflation, Ryan L.