Scribd
Upload
19 views9 pages

Apuntes Unit 2

Uploaded by

Sara Tapia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
19 views9 pages

Apuntes Unit 2

Uploaded by

Sara Tapia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 9

____________UNIT 2: FISCAL POLICY______________________________

INDEX
- The aggregate demand: consumption and investment.
- Fiscal policy.
- The fiscal multiplier.
- Taxes.
- The contractionary fiscal policy.
- The public budget.
- The IS curve.

1. AGGREGATE DEMAND

Economic activity
- Fluctuates from year to year
Recession
- Economic contraction
- Period of declining real incomes and rising unemployment
Depression
- Severe recession

Economic fluctuations
Three key facts about economic fluctuations
1. Economic fluctuations are irregular and unpredictable
- The business cycle
2. Most macroeconomic quantities fluctuate together
- Recessions → economy-wide phenomena
3. As output falls, unemployment rises
Short-Run Economic Fluctuations
AD-AS model
- Model of aggregate demand (AD) & aggregate supply (AS)
- Most economists use it to explain short-run fluctuations in economic activity
▪ Around its long-run trend

Aggregate-demand curve
- Shows the quantity of goods and services
- That households, firms, the government, and customers abroad
- Want to buy at each price level
- Downward sloping

Aggregate-supply curve
- Shows the quantity of goods and services
- That firms choose to produce and sell
- At each price level
- Upward sloping
AGGREGATE DEMAND CURVE
Three effects – explain why AD curve slopes downward:
- Wealth effect (C )
- Interest-rate effect (I)
- Exchange-rate effect (NX)
- Assumption: government spending (G)
- Fixed by policy

Y = C + I + G + NX

Price level & consumption (C): wealth effect


- Decrease in price level
▪ Increase - real value of money
▪ Consumers – wealthier
▪ Increase in consumer spending
▪ Increase in quantity demanded of goods & services
Price level & investment (I): interest-rate effect
- Decrease in price level
▪ Decrease – interest rate
▪ Increase spending on investment goods
▪ Increase in quantity demanded of goods & services

Price level & net exports (NX): exchange-rate effect


- Decrease in EURO price level
▪ Decrease – interest rate
▪ EURO – depreciates
▪ Stimulates the EU. net exports
▪ Increase in quantity demanded of goods & services

A fall in price level


- Increases quantity of goods and services demanded
Because:
1. Consumers are wealthier - stimulates the demand for consumption goods
2. Interest rates fall - stimulates the demand for investment goods
3. Currency depreciates - stimulates the demand for net exports
A rise in price level
- Decreases the quantity of goods and services demanded
Because:
1. Consumers are poorer – depress consumer spending
2. Higher interest rates fall - depress investment spending
3. Currency appreciates – depress net exports

The AD curve might shift:


- Changes in consumption
- Changes in investment
- Changes in government purchases
- Changes in net exports

Changes in consumption, (C):


- Events that change how much people want to consume at a given price level
▪ Changes in taxes, wealth
- Increase in consumer spending
▪ Aggregate demand - shift right

Changes in investment, (I):


- Events that change how much firms want to invest at a given price level
▪ Better technology
▪ Tax policy
▪ Money supply
- Increase in investment
▪ Aggregate demand - shift right

Changes in government purchases, (G):


- Policy makers – change government spending at a given price level
▪ Build new roads
- Increase in government purchases
▪ Aggregate demand - shift right

Changes in net exports, (NX):


- Events that change net exports for a given price level
▪ Recession in Europe
▪ International speculators – change in exchange rate
- Increase in net exports
▪ Aggregate demand - shift right

2. FISCAL POLICY INFLUENCES AD

Fiscal policy
- Government policymakers
- Set the level of government spending and taxation
▪ Shift the aggregate demand:
1. Multiplier effect
2. Crowding-out effect

The multiplier effect


- Additional shifts in aggregate demand
▪ Result when expansionary fiscal policy increases income
▪ And thereby increases consumer spending

Example:
The multiplier effect of an increase in
government purchases by $20 billion:
- Aggregate-demand curve
▪ Shifts right by exactly $20 billion
- Consumers respond
▪ Increase spending
- Aggregate-demand curve
▪ Shifts right again

Multiplier effect
- Response of consumer spending
- Response of investment

Investment accelerator
- Higher government demand
▪ Higher demand for investment goods
- Positive feedback from demand to investment

Spending multiplier
- Marginal propensity to consume, MPC
▪ Fraction of extra income that
consumers spend
- Size of the multiplier
▪ Depends on the MPC
- A larger MPC
▪ Larger multiplier

Because of multiplier effect


- $1 of government purchases
▪ Can generate > $1 of aggregate demand
- $1 of consumption, investment, or net exports
▪ Can generate > $1 of aggregate demand

The crowding-out effect


- Offset in aggregate demand
- Results when expansionary fiscal policy raises the interest rate
- Thereby reduces investment spending

The crowding-out effect of an increase in government spending


- Aggregate demand curve – shifts right
▪ Increase in income
▪ Money demand – increases
▪ Interest rate – increases
▪ Aggregate-demand curve – shifts left

A decrease in personal income taxes


- Households income – increases
- Multiplier effect
▪ Aggregate demand -- increases
- Crowding-out effect
▪ Aggregate demand – decreases
- Permanent tax cut - large impact on AD
- Temporary tax cut - small impact on AD

Using policy for stabilisation:


The case for active stabilisation policy:
- A change in aggregate – demand  use
fiscal policy
- The central bank  use monetary policy
- To stabilise the economy

Keynes
- Key role of AD in explaining short-run
economic fluctuations
- The government should actively stimulate
aggregate demand
▪ When AD appeared insufficient to maintain
production at its full-employment level

You might also like