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Unit 12 - Lesson 2 Fiscal Policy

This document discusses fiscal policy and its goals of stable price levels, full employment, and economic growth. It explains that fiscal policy involves manipulating government expenditures and taxes to influence aggregate demand. Expansionary fiscal policy, such as increasing government spending or decreasing taxes, is used to increase aggregate demand and close a recessionary gap. Contractionary fiscal policy, such as decreasing spending or increasing taxes, is used to decrease aggregate demand and close an inflationary gap. The document also notes the ratchet effect, where price levels remain elevated even after aggregate demand decreases.

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2K views7 pages

Unit 12 - Lesson 2 Fiscal Policy

This document discusses fiscal policy and its goals of stable price levels, full employment, and economic growth. It explains that fiscal policy involves manipulating government expenditures and taxes to influence aggregate demand. Expansionary fiscal policy, such as increasing government spending or decreasing taxes, is used to increase aggregate demand and close a recessionary gap. Contractionary fiscal policy, such as decreasing spending or increasing taxes, is used to decrease aggregate demand and close an inflationary gap. The document also notes the ratchet effect, where price levels remain elevated even after aggregate demand decreases.

Uploaded by

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Fiscal Policy

Unit 12 - Lesson 2

Learning outcomes:

Explain how changes in the level of government expenditure &/or taxes can
influence the level of Aggregate Demand.
Describe the mechanism through which expansionary fiscal policy can help
an economy close a recessionary gap.
Construct a diagram to show the potential effects of expansionary fiscal
policy, outlining the importance of the Aggregate Supply curve.
Describe the mechanism through which contractionary fiscal policy can help
an economy close an inflationary gap.
Construct a diagram to show the potential effects of contractionary fiscal
policy, outlining the importance of the Aggregate Supply curve.

Macroeconomic Objective
The Macroeconomic Objective of an
economy is to:
1. Stable Price Levels
2. Full Employment
3. Economic Growth
Where:
Actual output = Potential output
Unemployment = NRU

Tragakes, pg. 253

Fiscal Policy
Manipulation by the government of its expenditures and taxes
in order to influence Aggregate Demand.
Fiscal Policy can influence 3 of the 4 components of
Aggregate Demand:
1. Government Spending - G
2. Consumption Spending - C - changes in taxes
3. Investment Spending - I - changes in taxes

Expansionary Fiscal Policy


Economy is experiencing a Recessionary Gap:

Actual Output < Potential Output


Unemployment > NRU

Expansionary Fiscal Policy

Goal is increase Aggregate Demand in order to achieve Full


Employment:
AO = PO
Unemployment = NRU

Policies may consist of:


1.
2.
3.

Increasing Government Spending


Decreasing Personal Income Taxes
Combination of both

Tragakes, pg. 322

Contractionary Fiscal Policy


Economy is experiencing an Inflationary Gap

Actual Output > Potential Output


Unemployment < NRU

Contractionary Fiscal Policy


Goal is to decrease Aggregate Demand in order to reach Full
Employment

AO = PO
Unemployment = NRU

Policies may consist of:


1.
2.
3.

Decreasing Government Spending


Increasing Taxes
Combination of both

Tragakes, pg. 342

Ratchet Effect
Ratchet Effect

Price Levels increase when there is an


increase in AD and economy experiences an
Inflationary Gap.
Though when there is a decrease in AD,
Price Levels will remain the same and Real
GDP will decrease.
This is a more realistic representation of what
happens in the real world.

Tragakes, pg. 342

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