Chapter 15Chapter 15

Debates on Debates on Macroeconomic Macroeconomic PolicyPolicy

Day OneDay One

Main FocusMain Focus Inflation and UnemploymentInflation and Unemployment The Phillips CurveThe Phillips Curve Wages and Price PoliciesWages and Price Policies The Debate Over wage and Price The Debate Over wage and Price

PoliciesPolicies

Inflation and UnemploymentInflation and Unemployment

Relationship between inflation and unemployment is inverseRelationship between inflation and unemployment is inverse ·  AD ·  AD PL and O PL and O Inflation Inflation Unemployment Unemployment 1.     There is an increase in Aggregate Demand (AD) during 1.     There is an increase in Aggregate Demand (AD) during

an economic expansion (people consume, invest more) an economic expansion (people consume, invest more) 2.     b/c of AD ↑ there is a higher equilibrium price level and 2.     b/c of AD ↑ there is a higher equilibrium price level and

output. output. ·        A price level ↑ leads to inflation·        A price level ↑ leads to inflation ·        An output ↑ leads to lower unemployment·        An output ↑ leads to lower unemployment 3.     because the AD has pushed up the price level, the 3.     because the AD has pushed up the price level, the

resulting INFLATION is demand pull inflation resulting INFLATION is demand pull inflation

Demand-pull inflationDemand-pull inflation – inflation that occurs as increased – inflation that occurs as increased aggregate demand pulls up pricesaggregate demand pulls up prices

Demand- Pull InflationDemand- Pull Inflation

The Phillips CurveThe Phillips Curve TThe Phillips Curve expresses the inverse he Phillips Curve expresses the inverse

relationship of unemployment and inflation. relationship of unemployment and inflation. - aggregate demand - ª    unemployment - «    - aggregate demand - ª    unemployment - «    inflation - ª inflation - ª - aggregate demand - «    unemployment - ª     - aggregate demand - «    unemployment - ª     inflation - « inflation - « - on Fig. 15.2, the inverse relationship is shown. - on Fig. 15.2, the inverse relationship is shown.

**The curve is rarely straight **The curve is rarely straight - also used by governments as a policy menu. - also used by governments as a policy menu. Expansionary fiscal or monetary policies would Expansionary fiscal or monetary policies would move an economy up the curve, contractionary move an economy up the curve, contractionary policies would cause a move down. policies would cause a move down. - the effect to which the curve is applicable can be - the effect to which the curve is applicable can be shown in 3 different time periods. shown in 3 different time periods.

The Phillips CurveThe Phillips Curve

From 1960 to 1972From 1960 to 1972

• • TThere was generally higher inflation with here was generally higher inflation with lower unemployment (thus there was lower unemployment (thus there was demand pull inflation). Since the points demand pull inflation). Since the points fell in fell in a broad banda broad band a Phillips Curve a Phillips Curve could be drawn and used to predict how could be drawn and used to predict how stabilization policies would affect the stabilization policies would affect the economyeconomy

Shifts in the Philips CurveShifts in the Philips Curve

From 1973 to 1982From 1973 to 1982

• • GGenerally inflation and unemployment enerally inflation and unemployment were both higher %. Their relationship were both higher %. Their relationship was sometimes direct: a rise in inflation was sometimes direct: a rise in inflation would accompany a rise or non-would accompany a rise or non-movement in unemployment. This movement in unemployment. This caused caused stagflationstagflation

Cost Push InflationCost Push Inflation

From 1983 to 1993From 1983 to 1993

• • UUnemployment rates remained generally nemployment rates remained generally high, but inflation rates generally lower. high, but inflation rates generally lower. Because of an inconsistent relationship, Because of an inconsistent relationship, the Phillips curve could not be drawn for the Phillips curve could not be drawn for this period. this period.

•      •      Inflation was lower because oil prices Inflation was lower because oil prices dropped, reducing cost-push inflation, dropped, reducing cost-push inflation, and because of an economic recession.and because of an economic recession.

Wages and Wages and

Price PoliciesPrice Policies

Wages and Price PoliciesWages and Price Policies

In the 70’s and 80’s, gov’ts were looking In the 70’s and 80’s, gov’ts were looking for solutions to stagflationfor solutions to stagflation

They tried -Wage and Price Controls and They tried -Wage and Price Controls and Guidelines.Guidelines.

Wage and Price Controls:Wage and Price Controls: - When gov’ts impose restrictions on - When gov’ts impose restrictions on

wage and price increases. (ex. Minimum wage and price increases. (ex. Minimum wage can increase by only a certain % a wage can increase by only a certain % a year).year).

Wage and Price Guidelines:Wage and Price Guidelines: - Voluntary restrictions on wage and - Voluntary restrictions on wage and

prices increasesprices increases

1969 - 19751969 - 1975

Guidelines didn’t work because Guidelines didn’t work because businesses wouldn’t cooperate.businesses wouldn’t cooperate.

A Prices and Incomes Commission was A Prices and Incomes Commission was created to work with businesses but created to work with businesses but nobody listened to themnobody listened to them

Inflation actually rose from 5% in 1969 to Inflation actually rose from 5% in 1969 to 10% in 1975.10% in 1975.

1976 - 19781976 - 1978

Controls were then tried:Controls were then tried: - In ‘76 to ’78, a maximum % that wages - In ‘76 to ’78, a maximum % that wages

and salaries could increase was imposedand salaries could increase was imposed Businesses could only increase prices to Businesses could only increase prices to

cover increased costs. cover increased costs.

The result…The result…

Inflation did subside (10% - 7.5%) during Inflation did subside (10% - 7.5%) during the time the controls were in placethe time the controls were in place

Economists thought the price and wage Economists thought the price and wage controls weren’t the cause, but rather the controls weren’t the cause, but rather the lower food prices.lower food prices.

After the controls were lifted, inflation After the controls were lifted, inflation rose again.rose again.

1982 – 1984 “Six and Five” Rule1982 – 1984 “Six and Five” Rule

In this time the gov’t tried controls again, In this time the gov’t tried controls again, but only on things the federal government but only on things the federal government directly controlled.directly controlled.

They increased wages and prices by 6% They increased wages and prices by 6% in ’82-’83, then 5% in ‘83-’84.in ’82-’83, then 5% in ‘83-’84.

The government encouraged provincial The government encouraged provincial gov’ts to follow their controls.gov’ts to follow their controls.

The Result…The Result…

A dramatic fall in inflation between 1982 A dramatic fall in inflation between 1982 and 1984, but once again this was and 1984, but once again this was contributed to outside factors:contributed to outside factors:

- The current economic recessionThe current economic recession

- The contractionary policies put in place The contractionary policies put in place by the Bank of Canada at the timeby the Bank of Canada at the time

The Debate Over The Debate Over Wage and Price Wage and Price PoliciesPolicies

Is It Effective?Is It Effective?

Guidelines are only voluntary in the Guidelines are only voluntary in the private sector, and have very little private sector, and have very little success because most businesses do success because most businesses do not follow themnot follow them

Wage & Price controls may reduce Wage & Price controls may reduce inflation in the short run, but after the inflation in the short run, but after the controls are removed, inflation almost controls are removed, inflation almost instantaneously rises.instantaneously rises.

How Fair Is It?How Fair Is It?

Larger businesses have to deal with stricter Larger businesses have to deal with stricter rules from the government whereas smaller rules from the government whereas smaller businesses find it easier to increase wages.businesses find it easier to increase wages.

Not all businesses operate within these Not all businesses operate within these restrictions, with some ‘under-the-table’ restrictions, with some ‘under-the-table’ incentives on top of the legal price to incentives on top of the legal price to encourage more salesencourage more sales

How Efficient Is It?How Efficient Is It?

Wage & Price restrictions inhibit functions of Wage & Price restrictions inhibit functions of free markets.free markets.

Wage restrictions break the link between Wage restrictions break the link between productivity & income, thus giving the workers productivity & income, thus giving the workers limited incentive to maximize work efforts and limited incentive to maximize work efforts and output.output.

Changes in Demand & Supply do not affect Changes in Demand & Supply do not affect price, so resources me be inefficiently price, so resources me be inefficiently distributeddistributed

Brief ReviewBrief Review

1. Inflation and unemployment have often had 1. Inflation and unemployment have often had an inverse relationship. In periods of an inverse relationship. In periods of expansion, the result is demand-pull inflationexpansion, the result is demand-pull inflation

2. The Phillips curve represents the Keynesian 2. The Phillips curve represents the Keynesian assumption of an inverse and predictable assumption of an inverse and predictable relationship between inflation and relationship between inflation and unemployment. While the Phillips curve applied unemployment. While the Phillips curve applied to Canada in the period form 1960 to 1972, it to Canada in the period form 1960 to 1972, it has been less relevant since.has been less relevant since.

Brief ReviewBrief Review

3. Since the 1970s, inflation and unemployment in 3. Since the 1970s, inflation and unemployment in Canada have frequently had a direct relationship. Canada have frequently had a direct relationship. Stagflation has been caused largely by decreases Stagflation has been caused largely by decreases in aggregate supply due to price increase of in aggregate supply due to price increase of inputs. The result is cost –push inflationinputs. The result is cost –push inflation

4. Overall inflation and unemployment rates in 4. Overall inflation and unemployment rates in Canada increased in the period from 1973 to 1982, Canada increased in the period from 1973 to 1982, shifting the Phillips curve to the right. From 1983 to shifting the Phillips curve to the right. From 1983 to 1993, unemployment continued to be high but 1993, unemployment continued to be high but inflation lowered.inflation lowered.

Brief ReviewBrief Review

5. Various types of wage and price 5. Various types of wage and price restrictions have been applied in Canada restrictions have been applied in Canada since 1969. Critics suggest that these since 1969. Critics suggest that these program show little success, while program show little success, while fostering inequalities and inefficiency. fostering inequalities and inefficiency.

End of Day End of Day OneOne

Day TwoDay Two

Main FocusMain Focus

MonetarismMonetarism The Velocity of MoneyThe Velocity of Money The Equation of ExchangeThe Equation of Exchange The Quantity of MoneyThe Quantity of Money Inflation Rates and Monetary GrowthInflation Rates and Monetary Growth Monetarist PoliciesMonetarist Policies

MonetarismMonetarism

Monetarism: Monetarism: It is an economic perspective that It is an economic perspective that emphasizes the influence of money on the economy & emphasizes the influence of money on the economy & the ability of private markets to accommodate changethe ability of private markets to accommodate change

Monetarists VS KeynesiansMonetarists VS Keynesians -Referred to the economist -Referred to the economist KeynesiansKeynesians, , fiscal and fiscal and

monetary policiesmonetary policies perform a perform a beneficial rolebeneficial role by by smoothing the ups and downs of the business cyclesmoothing the ups and downs of the business cycle

- KeynesiansKeynesians tend to see fiscal policy as tend to see fiscal policy as more more powerfulpowerful

- Believes that private markets are unsteady, and Believes that private markets are unsteady, and occasional government intervention is necessary.occasional government intervention is necessary.

continuecontinue Monetarism: Monetarism: monetarism is a recent extension of the monetarism is a recent extension of the

theories that dominated macroeconomicstheories that dominated macroeconomics Monetarists believe that the economy is able to adjust Monetarists believe that the economy is able to adjust

to fluctuations without government interventionto fluctuations without government intervention argues that, misguided government intervention just argues that, misguided government intervention just

makes economic fluctuation worse.makes economic fluctuation worse. Why?Why?* Because they stress the importance of money, * Because they stress the importance of money,

monetarists blame unwise use of monetary policies in monetarists blame unwise use of monetary policies in particular.particular.

The Velocity of MoneyThe Velocity of Money

Concept Central to Monetarism known as Concept Central to Monetarism known as Velocity of MoneyVelocity of Money : the number of times, on : the number of times, on

average, the money is spent on final goods and average, the money is spent on final goods and services during given year is the velocity of moneyservices during given year is the velocity of money

Nominal GDPNominal GDP

Velocity of Money (V) =Velocity of Money (V) = Money Supply (M)Money Supply (M)

Nominal GDP:Nominal GDP: total dollar value of final goods and total dollar value of final goods and services produced in economyservices produced in economy

Money supply (M) = M1Money supply (M) = M1 (publicly held currency (publicly held currency and publicly held deposits, excluding cash reserves)and publicly held deposits, excluding cash reserves)

Activity Exercise!!!!!Activity Exercise!!!!!

Write the equation to calculate Write the equation to calculate VELOCITY OF MONEYVELOCITY OF MONEY

Now Calculate the velocity of money if Now Calculate the velocity of money if Canada’s nominal GDP is $800 billion Canada’s nominal GDP is $800 billion and the money supply (M) is $50 billionand the money supply (M) is $50 billion

ANSWER!!!ANSWER!!!

1) 1) Nominal GDPNominal GDP

Velocity of Money (V) =Velocity of Money (V) = Money Supply (M)Money Supply (M)

2) 2) $800 billion$800 billion

16 = $ 50 billion16 = $ 50 billion

The Equation of ExchangeThe Equation of Exchange

Equation of ExchangeEquation of Exchange - the money supply - the money supply multiplied by the velocity of money equals price multiplied by the velocity of money equals price level multiplied by real output. level multiplied by real output.

Given: Nominal GDP = P x QGiven: Nominal GDP = P x Q

800 billion = 2.0 x 400 billion800 billion = 2.0 x 400 billion We can find the equation of exchange!We can find the equation of exchange!

Money Supplied (M) x Velocity of Money (V) Money Supplied (M) x Velocity of Money (V) = price level (P) x real output (Q)= price level (P) x real output (Q)

The Quantity of MoneyThe Quantity of Money

The Quantity of MoneyThe Quantity of Money – a theory stating that the – a theory stating that the velocity of money and real output are relatively stable velocity of money and real output are relatively stable over short periods.over short periods. V only displays gradual change because changes are primarily V only displays gradual change because changes are primarily

due to long run factors (like a move to credit and debit cards)due to long run factors (like a move to credit and debit cards) Real output – varies only slightly from its potential level Real output – varies only slightly from its potential level

because there is quick adjustment to any changes in prices or because there is quick adjustment to any changes in prices or unemployment. unemployment.

Therefore: according to the quantity of money theory, both V Therefore: according to the quantity of money theory, both V and Real Output are constantand Real Output are constant

SO, given SO, given M x V = P x QM x V = P x Q , changes in price level must be due , changes in price level must be due to changes in money supply. For example: Inflation (↑ P) is to changes in money supply. For example: Inflation (↑ P) is due to too much money chasing the products available for due to too much money chasing the products available for purchase in the economy (↑M)purchase in the economy (↑M)

The Velocity of MoneyThe Velocity of Money

Inflation Rate and Monetary Inflation Rate and Monetary GrowthGrowth

• The quantity theory shows a close relationship The quantity theory shows a close relationship between inflation and growth in money supply between inflation and growth in money supply

• If M1 were to increase by 10%, so would P If M1 were to increase by 10%, so would P • change in P = inflation. V and Q are very change in P = inflation. V and Q are very

constant constant • equality between M and P is evident, but equality between M and P is evident, but

sometimes rough. sometimes rough.

Monetarist PoliciesMonetarist Policies

Money is the key factor in the economy, unlike Money is the key factor in the economy, unlike Keynesians who believe it is only one of many Keynesians who believe it is only one of many factors factors

Fiscal policy has little influence due to “crowding Fiscal policy has little influence due to “crowding out effect”out effect”

Crowding - Out - Effect:Crowding - Out - Effect: The effect of more government The effect of more government borrowing raising interest rates, which reduces or “crowds out” borrowing raising interest rates, which reduces or “crowds out” private investment spendingprivate investment spending

Even monetary policy cannot change output from Even monetary policy cannot change output from its potential level its potential level

Only way to stabilize economy is minimizing Only way to stabilize economy is minimizing harmful effects of inflation, when bank of Canada harmful effects of inflation, when bank of Canada minimizes rate of growth of money supply minimizes rate of growth of money supply

Comparing the TwoComparing the Two

KeynesiansKeynesians Treat money as only one element that determines output and inflation Treat money as only one element that determines output and inflation

levelslevels See the process through which money influences the economy is a See the process through which money influences the economy is a

lengthy one (an expansion in the money supply must first reduce interest lengthy one (an expansion in the money supply must first reduce interest rates, then boost investment spending, resulting in an increase in AD)rates, then boost investment spending, resulting in an increase in AD)

Regard fiscal policy as a powerful stabilization toolRegard fiscal policy as a powerful stabilization toolMonetaristsMonetarists Consider variations in the money supply the most significant factor in the Consider variations in the money supply the most significant factor in the

economyeconomy See the impact of monetary changes as being more straightforward and See the impact of monetary changes as being more straightforward and

predictable (assuming stable velocity of money, adjustments in the money predictable (assuming stable velocity of money, adjustments in the money supply translate immediately into higher nominal GDP and increased supply translate immediately into higher nominal GDP and increased prices)prices)

Argue that fiscal policy has little influence because of the Argue that fiscal policy has little influence because of the crowding out crowding out effecteffect

Monetary RuleMonetary Rule

The Monetary RuleThe Monetary Rule The monetary rule The monetary rule forces forces

central banks to increase the central banks to increase the money supply by a constant money supply by a constant rate each yearrate each year

Recommended at 3% based on Recommended at 3% based on real long-termreal long-term growth in economy growth in economy

Brief Review for Day TwoBrief Review for Day Two

1. In contrast to Keynesians, monetarists believe that 1. In contrast to Keynesians, monetarists believe that the economy has an ability to adjust itself, that the economy has an ability to adjust itself, that governments intervention can harm rather than help governments intervention can harm rather than help the economy, and that the money supply is of ventral the economy, and that the money supply is of ventral importance to the economy.importance to the economy.

2. The equation of exchange states that the money 2. The equation of exchange states that the money supply (M) multiplied by the velocity of money (V) supply (M) multiplied by the velocity of money (V) equals the price level (P) multiplied by the real output equals the price level (P) multiplied by the real output (Q) or nominal GDP.(Q) or nominal GDP.

Brief Review for Day TwoBrief Review for Day Two

3. According to the quantity theory of money, both the 3. According to the quantity theory of money, both the velocity of money and real output are relatively stable velocity of money and real output are relatively stable over short periods. A certain percentage change in the over short periods. A certain percentage change in the money supply causes about the same rate of inflation.money supply causes about the same rate of inflation.

4. Keynesians see the influence of money as indirect 4. Keynesians see the influence of money as indirect and fragile, and fiscal policy as an important and fragile, and fiscal policy as an important stabilization tool. In contrast, monetarist see the stabilization tool. In contrast, monetarist see the influence of money as direct, fiscal policy as ineffective influence of money as direct, fiscal policy as ineffective but easily misused.but easily misused.

5. Monetarists recommend a monetary rule, whereby 5. Monetarists recommend a monetary rule, whereby the money supply is raised by a set annual rate based the money supply is raised by a set annual rate based on the economy’s real growth.on the economy’s real growth.

End of Day End of Day TwoTwo

Day ThreeDay Three

Main FocusMain Focus

Supply- Side EconomicsSupply- Side Economics Reduction in IncentivesReduction in Incentives Focus on Aggregate SupplyFocus on Aggregate Supply The Laffer CurveThe Laffer Curve The Influence of Supply Side TheoriesThe Influence of Supply Side Theories

Supply Side EconomicsSupply Side Economics

Most economists stress how fiscal and monetary policies Most economists stress how fiscal and monetary policies influence the economy through shifts in aggregate demand, this influence the economy through shifts in aggregate demand, this follows from their view that any effects on aggregate supply are follows from their view that any effects on aggregate supply are minorminor

However, some economists subscribe to a viewpoint known as However, some economists subscribe to a viewpoint known as supply-side economicssupply-side economics

They believe that the aggregate supply is the most critical element They believe that the aggregate supply is the most critical element of government activity and, because the effects are gradual and of government activity and, because the effects are gradual and often hidden, they are usually ignored by policy-makersoften hidden, they are usually ignored by policy-makers

The supply-side economists own a large debt to the theories of The supply-side economists own a large debt to the theories of early classical economists, such as Adam Smith and Davis early classical economists, such as Adam Smith and Davis Ricardo, who concentrated on the influence of production costs on Ricardo, who concentrated on the influence of production costs on price and incomesprice and incomes

Reduction in IncentivesReduction in Incentives

Reduction in IncentivesReduction in Incentives Supply-side economists believe increased government Supply-side economists believe increased government

intervention in recent decades has dampened intervention in recent decades has dampened productive economic activityproductive economic activity

According to the supply-siders, the government activity According to the supply-siders, the government activity can affect aggregate supply by reducing incentives to can affect aggregate supply by reducing incentives to engage in productive activityengage in productive activity

Personal Income and Business TaxesPersonal Income and Business Taxes Anytime marginal tax rates on personal income and Anytime marginal tax rates on personal income and

business profits increase, the business profits increase, the disposable incomesdisposable incomes of of income earners fall, making it less worthwhile for them income earners fall, making it less worthwhile for them to engage in income generating pursuitsto engage in income generating pursuits

Sales TaxesSales Taxes Hikes in sales taxes also discourage productive activity Hikes in sales taxes also discourage productive activity

by reducing the amount of product that can be bought by reducing the amount of product that can be bought with a given incomewith a given income

Transfers and SubsidiesTransfers and Subsidies Supply-siders criticize more generous transfer payment Supply-siders criticize more generous transfer payment

programs, such as Unemployment Insurance and programs, such as Unemployment Insurance and welfare, as well as subsidy programs such as farm welfare, as well as subsidy programs such as farm subsidies. According to the economists, such programs subsidies. According to the economists, such programs diminish incentives to generate private income.diminish incentives to generate private income.

RegulationRegulation Government has also played a greater Government has also played a greater

role in regulating private businesses. role in regulating private businesses. Controls associates with environmental Controls associates with environmental concerns, worker safety, product concerns, worker safety, product standards, and workplace equity have all standards, and workplace equity have all raised business costs and reduced raised business costs and reduced incentives to investincentives to invest

Aggregate SupplyAggregate Supply

Monetarists = Gov’t policies affect aggregate Monetarists = Gov’t policies affect aggregate demand seriouslydemand seriously

Keynesians = Gov’t policies affect aggregate Keynesians = Gov’t policies affect aggregate demand seriouslydemand seriously

Supply-Siders = Gov’t policies have little effect Supply-Siders = Gov’t policies have little effect on aggregate demand and a huge effect on on aggregate demand and a huge effect on aggregate supply.aggregate supply.

Focus on Aggregates SupplyFocus on Aggregates Supply

Supply-side economists contend that increases in Supply-side economists contend that increases in taxes and government regulation means a decrease in taxes and government regulation means a decrease in aggregate supply.aggregate supply.

This shifts the AS curve from AS0 to AS1. Therefore, This shifts the AS curve from AS0 to AS1. Therefore, the economy is pushed to a higher price level (P ) and the economy is pushed to a higher price level (P ) and lower real output (Q ) (from point ‘b’ to point ‘a’) lower real output (Q ) (from point ‘b’ to point ‘a’)

Cost-push inflationCost-push inflation then occurs: increased production then occurs: increased production costs due to taxes and gov’t regulation, decrease costs due to taxes and gov’t regulation, decrease aggregate supply, which pushes up pricesaggregate supply, which pushes up prices

Effect of Government Effect of Government InterventionIntervention

Supply-Siders’ ViewsSupply-Siders’ Views

They say high taxes and increased government They say high taxes and increased government regulation create cost-push inflationregulation create cost-push inflation

Therefore they feel the stagflation of the 1970’s Therefore they feel the stagflation of the 1970’s was caused by the government unintentionally was caused by the government unintentionally because the government over-intervened.because the government over-intervened.

Tax cuts and reduced regulation should right the Tax cuts and reduced regulation should right the economy, increasing aggregate supplyeconomy, increasing aggregate supply

ReaganomicsReaganomics

In the early 80’s, supply-siders had many proposals In the early 80’s, supply-siders had many proposals legislated (such as reduction in personal and business legislated (such as reduction in personal and business taxes), and came to be associated with the Reagan taxes), and came to be associated with the Reagan presidency in the United States.presidency in the United States.

Supply-siders suggested that reducing tax Supply-siders suggested that reducing tax ratesrates would would actually lead to an increase in total tax actually lead to an increase in total tax revenues.revenues.

The economy underwent a wave of deregulation.The economy underwent a wave of deregulation.

The Laffer CurveThe Laffer Curve

Laffer curve is a curve that expresses the assumed relationship between Laffer curve is a curve that expresses the assumed relationship between tax rates and tax revenuestax rates and tax revenues

According to the supply- side economics, tax increases at lower tax rates According to the supply- side economics, tax increases at lower tax rates increase tax revenues (from points increase tax revenues (from points a a to to bb). However, at higher tax rates ). However, at higher tax rates (point (point bb to to dd), tax increases reduce tax revenues as there is little incentive ), tax increases reduce tax revenues as there is little incentive to produce more, make higher incomes, and be taxed more. As a result, a to produce more, make higher incomes, and be taxed more. As a result, a cut in the tax rate from 40% to 20% (from point cut in the tax rate from 40% to 20% (from point cc to point to point bb) increases tax ) increases tax revenues (read pg.461)revenues (read pg.461)

Tax rates and tax revenues have a direct relationship at low tax rates (a Tax rates and tax revenues have a direct relationship at low tax rates (a positive slope at lower tax rates)positive slope at lower tax rates)

Tax rates and tax revenues have a direct relationship at high tax rates (a Tax rates and tax revenues have a direct relationship at high tax rates (a negative slope at higher tax rates)negative slope at higher tax rates)

Applying the Laffer CurveApplying the Laffer Curve According to the supply-siders, the economies of countries such as According to the supply-siders, the economies of countries such as

Canada and the United States had already reached or surpassed the tax Canada and the United States had already reached or surpassed the tax rate at which revenues are maximized. Therefore, cutting tax rates as rate at which revenues are maximized. Therefore, cutting tax rates as from 40% to 20% would lead to an increase in revenuesfrom 40% to 20% would lead to an increase in revenues

The Laffer CurveThe Laffer Curve

The Influence of Supply- Side The Influence of Supply- Side TheoriesTheories

• Reaganomic tax cuts were an expensive Reaganomic tax cuts were an expensive mistake for the U.S. mistake for the U.S.

• mainstream economists said the government mainstream economists said the government deficit acted as an expansionary fiscal policy, deficit acted as an expansionary fiscal policy, raising aggregate demand causing the boom in raising aggregate demand causing the boom in the U.S.' economy. the U.S.' economy.

• most economists believe stabilization policies most economists believe stabilization policies effect aggregate demand more than aggregate effect aggregate demand more than aggregate supply. supply.

Brief Review For Day ThreeBrief Review For Day Three

1. Supply- side economists focus on the effect 1. Supply- side economists focus on the effect of changes in aggregate supply on the of changes in aggregate supply on the economy. They contend that increased economy. They contend that increased government intervention- in the form of higher government intervention- in the form of higher taxes, greater regulation, and so on – reduces taxes, greater regulation, and so on – reduces the incentive to engage in productive activity, the incentive to engage in productive activity, and so decreases aggregate supply.and so decreases aggregate supply.

2. Supply-side economists argue that tax hikes 2. Supply-side economists argue that tax hikes and added regulation were the main cause of and added regulation were the main cause of the stagflation of the 1970s.the stagflation of the 1970s.

Brief Review For Day ThreeBrief Review For Day Three

3. The Laffer curve represents the 3. The Laffer curve represents the supply-side economic belief that, if tax supply-side economic belief that, if tax rates are high enough, tax hikes lead to rates are high enough, tax hikes lead to reduced tax revenues.reduced tax revenues.

4. Supply- side theories were not borne 4. Supply- side theories were not borne out by their application in the United out by their application in the United States during the Reagon Administration.States during the Reagon Administration.

End of Day ThreeEnd of Day Three

Not sure if needed part of Not sure if needed part of the article on page456 the article on page456 and 457and 457