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PPT Econ Standardch24TRANSCRIPT
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© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 1 of 39
PowerPoint Lectures for
Principles of Economics, 9e
By
Karl E. Case, Ray C. Fair & Sharon M. Oster
; ;
© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster
PART V THE CORE OF MACROECONOMIC THEORY
24The Government
and Fiscal Policy
Fernando & Yvonn Quijano
Prepared by:
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24Government in the EconomyGovernment Purchases (G), Net Taxes (T),
and Disposable income (Y d)
The Determination of Equilibrium Output(Income)
Fiscal Policy at Work: Multiplier EffectsThe Government Spending MultiplierThe Tax Multiplier The Balanced-Budget Multiplier
The Federal BudgetThe Budget in 2007Fiscal Policy Since 1993: The Clinton and
Bush AdministrationsThe Federal Government Debt
The Economy’s Influence on the Government Budget Tax Revenues Depend on the State of the Economy Some Government Expenditures Depend on the
State of the EconomyAutomatic StabilizersFiscal DragFull-Employment Budget
Looking AheadAppendix A: Deriving the Fiscal Policy
Multipliers
Appendix B: The Case in Which Tax RevenuesDepend on Income
CHAPTER OUTLINE
The Government
and Fiscal Policy
PART V THE CORE OF MACROECONOMIC THEORY
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The Government and Fiscal Policy
fiscal policy The government’s spending and taxing policies.
monetary policy The behavior of the Federal Reserve concerning the nation’s money supply.
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Government in the Economy
discretionary fiscal policy Changes in taxes or spending that are the result of deliberate changes in government policy.
net taxes (T) Taxes paid by firms and households to the government minus transfer payments made to households by the government.
disposable, or after-tax, income (Yd) Total income minus net taxes: Y - T.
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
disposable income ≡ total income − net taxes
Yd ≡ Y − T
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
FIGURE 24.1 Adding Net Taxes (T) and Government Purchases (G) to the Circular Flow of Income
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
When government enters the picture, the aggregate income identity gets cut into three pieces:
Y Y Td
Y C Sd
Y T C S
Y C S T
And aggregate expenditure (AE) equals:
AE C I G
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
budget deficit The difference between what a government spends and what it collects in taxes in a given period: G - T.
budget deficit ≡ G − T
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
Adding Taxes to the Consumption Function
To modify our aggregate consumption function to incorporate disposable income instead of before-tax income, instead of C = a + bY, we write
C = a + bYd
or
C = a + b(Y − T)
Our consumption function now has consumption depending on disposable income instead of before-tax income.
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
Planned Investment
The government can affect investment behavior through its tax treatment of depreciation and other tax policies.
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Government in the Economy
The Determination of Equilibrium Output (Income)
Y = C + I + G
TABLE 24.1 Finding Equilibrium for I = 100, G = 100, and T = 100
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Output(Income)
Y
NetTaxes
T
DisposableIncome
Yd Y T
ConsumptionSpending
(C = 100 + .75 Yd)
SavingS
(Yd – C)
PlannedInvestmentSpending
I
GovernmentPurchases
G
PlannedAggregate
Expenditure C + I + G
UnplannedInventoryChange
Y (C + I + G)
Adjustmentto Disequi-
librium
300 100 200 250 50 100 100 450 150 Output500 100 400 400 0 100 100 600 100 Output700 100 600 550 50 100 100 750 50 Output900 100 800 700 100 100 100 900 0 Equilibrium
1,100 100 1,000 850 150 100 100 1,050 + 50 Output1,300 100 1,200 1,000 200 100 100 1,200 + 100 Output1,500 100 1,400 1,150 250 100 100 1,350 + 150 Output
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Government in the Economy
The Determination of Equilibrium Output (Income)
FIGURE 24.2 Finding Equilibrium Output/Income Graphically
Because G and I are both fixed at 100, the aggregate expenditure function is the new consumption function displaced upward by I + G = 200. Equilibrium occurs at Y = C + I + G = 900.
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Government in the Economy
The Determination of Equilibrium Output (Income)
The Saving/Investment Approach to Equilibrium
saving/investment approach to equilibrium:
S + T = I + G
To derive this, we know that in equilibrium, aggregate output (income) (Y) equals planned aggregate expenditure (AE). By definition, AE equals C + I + G; and by definition, Y equals C + S + T. Therefore, at equilibrium
C + S + T = C + I + G
Subtracting C from both sides leaves:
S + T = I + G
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Fiscal Policy at Work: Multiplier Effects
At this point, we are assuming that the government controls G and T. In this section, we will review three multipliers:
Government spending multiplier
Tax multiplier
Balanced-budget multiplier
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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
1government spending multiplier
MPS
government spending multiplier The ratio of thechange in the equilibrium level of output to a change in government spending.
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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
TABLE 24.2 Finding Equilibrium After a Government Spending Increase of 50 (G Has Increased from 100 in Table 24.1 to 150 Here)
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Output(Income)
Y
NetTaxes
T
DisposableIncome
Yd Y T
ConsumptionSpending
(C = 100 + .75 Yd)
SavingS
(Yd – C)
PlannedInvestmentSpending
I
GovernmentPurchases
G
PlannedAggregate
Expenditure C + I + G
UnplannedInventoryChange
Y (C + I + G)
AdjustmentTo
Disequilibrium
300 100 200 250 50 100 150 500 200 Output
500 100 400 400 0 100 150 650 150 Output
700 100 600 550 50 100 150 800 100 Output
900 100 800 700 100 100 150 950 50 Output
1,100 100 1,000 850 150 100 150 1,100 0 Equilibrium
1,300 100 1,200 1,000 200 100 150 1,250 + 50 Output
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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
FIGURE 24.3 The GovernmentSpending MultiplierIncreasing government spending by 50 shifts the AE function up by 50. As Y rises in response, additional consumption is generated. Overall, the equilibrium level of Y increases by 200, from 900 to 1,100.
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Fiscal Policy at Work: Multiplier Effects
The Tax Multiplier
tax multiplier The ratio of change in the equilibrium level of output to a change in taxes.
tax multiplier MPC
MPS
YM P S
( in itia l in c rease in ag g reg a te ex p en d itu re )
1
1( )
MPCY T MPC T
MPS MPS
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Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
balanced-budget multiplier The ratio of change in the equilibrium level of output to a change in government spending where the change in government spending is balanced by a change in taxes so as not to create any deficit. The balanced-budget multiplier is equal to 1: The change in Y resulting from the change in G and the equal change in T are exactly the same size as the initial change in G or T.
1balanced-budget multiplier
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Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
TABLE 24.3 Finding Equilibrium After a Balanced-Budget Increase in G and T of 200 Each (Both G and T Have Increased from 100 in Table 24.1 to 300 Here)
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Output(Income)
Y
NetTaxes
T
DisposableIncome
Yd Y T
ConsumptionSpending
(C = 100 + .75 Yd)
PlannedInvestmentSpending
I
GovernmentPurchases
G
PlannedAggregate
Expenditure C + I + G
UnplannedInventoryChange
Y (C + I + G)
AdjustmentTo
Disequilibrium
500 300 200 250 100 300 650 150 Output
700 300 400 400 100 300 800 100 Output
900 300 600 550 100 300 950 50 Output
1,100 300 800 700 100 300 1,100 0 Equilibrium
1,300 300 1,000 850 100 300 1,250 + 50 Output
1,500 300 1,200 1,000 100 300 1,400 + 100 Output
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Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
TABLE 24.4 Summary of Fiscal Policy Multipliers
Policy Stimulus MultiplierFinal Impact OnEquilibrium Y
Government spendingmultiplier
Increase or decrease in thelevel of governmentpurchases: ∆G
Tax multiplier Increase or decrease in thelevel of net taxes: ∆T
Balanced-budgetmultiplier
Simultaneous balanced-budgetincrease or decrease in thelevel of government purchasesand net taxes: ∆G = ∆T
1
1
M P S
M P C
M P S
1 G
MPS
MPC
TMPS
G
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The Federal Budget
federal budget The budget of the federal government.
The “budget” is really three different budgets.
First, it is a political document that dispenses favors to certain groups or regions and places burdens on others.
Second, it is a reflection of goals the government wants to achieve.
Third, the budget may be an embodiment of some beliefs about how (if at all) the government should manage the macroeconomy.
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The Federal Budget
The Budget in 2007
federal surplus (+) or deficit () Federal government receipts minus expenditures.
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The Economy’s Influence on the Government Budget
Tax Revenues Depend on the State of the Economy
Tax revenue, on the other hand, depends on taxable income, and income depends on the state of the economy, which the government does not completely control.
Some Government Expenditures Depend on the State of the Economy
Transfer payments tend to go down automatically during an expansion.
Inflation often picks up when the economy is expanding. This can lead the government to spend more than it had planned to spend.
Any change in the interest rate changes government interest payments.
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The Economy’s Influence on the Government Budget
Some Government Expenditures Depend on the State of the Economy
Fiscal Policy In 2008
Congress Approves Economic-Stimulus Bill
Wall Street Journal
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The Economy’s Influence on the Government Budget
Automatic Stabilizers
automatic stabilizers Revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to stabilize GDP.
Fiscal Drag
fiscal drag The negative effect on the economy that occurs when average tax rates increase because taxpayers have moved into higher income brackets during an expansion.
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The Economy’s Influence on the Government Budget
Full-Employment Budget
full-employment budget What the federal budget would be if the economy were producing at the full-employment level of output.
structural deficit The deficit that remains at full employment.
cyclical deficit The deficit that occurs because of a downturn in the business cycle.
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automatic stabilizers
balanced-budget multiplier
budget deficit
cyclical deficit
discretionary fiscal policy
disposable, or after-tax,
income (Yd)
federal budget
federal debt
federal surplus (+) or deficit (−)
fiscal drag
fiscal policy
full-employment budget
government spending multiplier
monetary policy
REVIEW TERMS AND CONCEPTS
net taxes (T)
privately held federal debt
structural deficit
tax multiplier
1. Disposable income Yd ≡ Y − T
2. AE ≡ C + I + G
3. Government budget deficit ≡ G − T
4. Equilibrium in an economy with government: Y = C + I + G
5. Saving/investment approach to equilibrium in an economy with government: S + T = I + G
6. Government spending multiplier ≡
7. Tax multiplier ≡
8. Balanced-budget multiplier ≡ 1
MPC
MPS
MPS
1
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DERIVING THE FISCAL POLICY MULTIPLIERS
A P P E N D I X A
THE GOVERNMENT SPENDING AND TAX MULTIPLIERS
Y C I G
C a b Y T ( )
Y a b Y T I G ( )
Y a bY bT I G Y bY a I G bT Y b a I G bT( )1
)(1
1bTGIa
b Y
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DERIVING THE FISCAL POLICY MULTIPLIERS
THE BALANCED-BUDGET MULTIPLIER
The balanced-budget multiplier is found by combining the effects of government spending and taxes:
Gincrease in spending:( )C T MPC - decrease in spending:( )G T MPC = net increase in spending
In a balanced-budget increase, ΔG = ΔT; so we can substitute:
net initial increase in spending:
ΔG − ΔG (MPC) = ΔG (1 − MPC)
A P P E N D I X A
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DERIVING THE FISCAL POLICY MULTIPLIERS
THE BALANCED-BUDGET MULTIPLIER
A P P E N D I X A
1( )Y G MPS G
MPS
Because MPS = (1 − MPC), the net initial increase in spending is:
ΔG (MPS)
We can now apply the expenditure multiplier to this net initial increase in spending:
MPS
1