Econ Macro Chap 12-13

what is fiscal policy about

the changes governments make to purchases, transfers, and taxes in trying to achieve the key macroeconomic outcomes of steady growth, full employment, and stable prices

what does fiscal policy work through

aggregate demand

what are all additional injections of spending in the simple gdp circular flow

government purchases, business investment spending, and exports are all additional injections of spending

what are the two main paths that transmit the effects of fiscal policy to aggregate demand

government purchases and net taxes

injection

spending in the circular flow that does not start with consumers

what happens to the aggregate demand curve when injections decrease

it shifts leftward

what happens to the aggregate demand curve when injections increase

it shifts rightward

leakage

spending that leaks out of the circular flow through taxes, savings, and imports

what are injections and leakages key in understanding

the multiplied impact of fiscal policy on aggregate demand and gdp

multiplier effect

a spending injection has a multiplied impact on real gdp

does the multiplier effect work in reverse

yes; a reduction in government spending, business investment spending, or rest of the world spending on Canadian exports has a multiplied impact reducing aggregate demand

what does the size of the multiplier effect depend on

leakages out of the circular flow

formula for calculating the size of the multiplier effect

size of the multiplier effect = 1 / % of leakages from additional income

what do more leakages mean

a smaller multiplier effect

what do fewer leakages mean

a larger multiplier effect

what is the size of the multiplier effect for government spending

about 2

what does a tax cut or an increase in transfer payments do

reduces leakages, leaving consumers with more money to spend and increasing aggregate demand

what is an increase in government spending or a decrease in taxes

a positive aggregate demand shock, shifting the aggregate demand curve rightward

what does the size of the rightward shift depend on

the size of the multiplier effect

what is a decrease in government spending or an increase in taxes

a negative aggregate demand shock, shifting the aggregate demand curve leftward by the multiplied effect of the initial decreased income

what does any change in injections have

it has a multiplied effect on aggregate demand and on real gdp

what are many canadian business cycles triggered by

changes in investment spending or exports

what happens when business investment spending decreases

there is a multiplied decrease in aggregate demand and real gdp (an important cause of the great depression)

what are expansions often triggered by

increases in business investment spending that increase aggregate demand with a multiplied impact on gdp

export-led growth

economic growth driven by the multiplied effects of increasing exports

what do multiplier effects do

they improve the effectiveness of fiscal policy as a tool for changing aggregate demand to counter business cycles

2 types of fiscal policy

expansionary and contractionary

expansionary fiscal policy

increases aggregate demand by increasing government spending, decreasing taxes, or increasing transfers

what kind of shock is expansionary fiscal policy

a positive aggregate demand shock for countering a recessionary gap

contractionary fiscal policy

decreases aggregate demand by decreasing government spending, increasing taxes, or decreasing transfers

what kind of shock is contractionary fiscal policy

a negative aggregate demand shock

what happens when the economy is in recession and far below potential gdp

more of the increase in aggregate demand increases real gpd

what happens when the economy is at or above potential gdp

more of the increase in aggregate demand drives up prices instead of increasing real gdp

what do the hands-on and hands-off camp agree on

that fiscal policy affects aggregate demand, real gdp, unemployment, and inflation

fiscal policy can affect aggregate supply and promote economic growth

hands-off camp belief on demand-side fiscal policies

if fiscal policy is necessary to accelerate the economy, they favor tax cuts instead of increased government spending; when slowing down the economy, they favor reduced government spending instead of tax cuts

hands-on camp belief on demand-side fiscal policies

fiscal policy is acceptable

if fiscal policy is necessary to slow down the economy, they favor tax increases over reduced government spending

what 3 outcomes do fiscal policies targeting aggregate supply aim for

stimulate saving and capital investment, encourage research and development, and improve education and trading

what promotes economic growth

government spending and tax incentives for research and development, and government-financed education and training that increase human capital

hands-off camp belief on supply-side fiscal policy

support fiscal policies to encourage saving and capital investment

hands-on camp belief on supply-side fiscal policy

see long-run benefits of increases saving for aggregate supply and economic growth, but they are concerned that short-run decreases in aggregate demand may cause a recession because markets fail to quickly adjust

what gives the same incentive as a wage increase

a tax cut

supply-side effects

the incentive effects of taxes on aggregate supply

what could happen if the government cuts taxes on labor as well as on capital investments

the quantities of labor and capital inputs supplied to markets could increase, and then aggregate supply increases

what do all economists believe

that tax cuts have incentive effects causing a small increase in aggregate supply — shifting both the LAS and SAS curves rightward

what do “supply-siders” claim

that tax cuts have powerful incentives, and claim that tax cuts will increase, not decrease, government tax revenues

what is the issue with supply-siders’ claim

it is usually exaggerated

what is government income called

revenue

what are the sources of government revenue

personal income taxes, corporate taxes, employment insurance premiums paid by workers and employers, GST/HST, etc.

what does the government spend on

purchases of products and services, transfer payments to businesses and individuals, and interest payments on the national debt

3 scenarios of the budget

balanced budget, budget deficit, budget surplus

balanced budget

revenues equals spending

budget deficit

revenues less than spending (negative number)

budget surplus

revenues greater than spending (positive number)

automatic stabilizers

tax and transfer adjustments that counteract changes to real gdp without explicit government decisions

what happens when a negative demand shock causes the economy to contract

government tax revenues fall and transfer payments increase

what happens when a positive demand shock causes the economy to expand

tax revenues increase and transfer payments decrease

what has happened since automatic stabilizers were introduced after the great depression

business cycles in canada have been less frequent, and contractions have been less severe

what do automatic stabilizers create

automatic deficits and surpluses

cyclical deficits/surpluses

created only as a result of automatic stabilizers counteracting business cycles

what is a cyclical deficit caused by

caused by a negative aggregate demand shock

what is a cyclical surplus caused by

caused by a positive aggregate demand shock

what makes recessions worse

government’s attempt to balance the budget during a recession, which decreases aggregate demand

what increases the risk of inflation

government’s attempt to balance the budget during an expansion, increasing aggregate demand

what does a balance budget over the business cycles cause

cyclical surpluses during expansions to offset cyclical deficits during contractios

what will a “good” balanced budget have

a surplus during the expansion and a deficit during the contraction

when is a budget balanced over the business cycle

if the positive amount of the surplus equals the negative amount of the deficit

structural deficit

occurs when government spend more than their revenues when the economy is at potential gdp and growing steadily

structural surplus

occurs when there is a government budget surplus while the economy is at potential gdp and growing steadily

which forms of surpluses/deficits are most concerning

structural

national debt

total amount owed by government = (sum of past deficits) - (sum of past surpluses)

what are deficits

a flow

what is debt

a stock

does the government of canada have to pay back the national debt

no, it can refinance it

what is a main concern of national debt

it can lead to self-perpetuating debt

crowding out

tendency for government debt-financed fiscal policy to decrease private investment spending by raising interest rates

crowding in

tendency for government debt-financed fiscal policy to increase private investment spending by improving expectations

absolute advantage

the ability to produce a product or service at a lower absolute cost than another producer

comparative advantage

the ability to produce a product or service at lower opportunity cost than another producer

terms of trade

quantity of exports required to pay for one unit of imports

what is the key to mutually beneficial gains from trade

comparative advantage

what is necessary for a trade to have mutual benefits

the terms of trade must be between each trader’s local opportunity costs

what does freer trade increase

competition

what is the downside of the gains from specialization, trade, competition, and innovation

destruction of less productive, higher-cost, and less popular products and businesses

what falls under the definition of structural unemployment

the jobs lost through trade, competition, and innovation

who are the winners when new international markets open up through trade

canadian consumers and businesses and workers in export industries

who are the losers when new international markets open up through trade

businesses and workers in import-competing industries

what do consumers gain from

lower prices and greater product variety that results from new imports

what happens if imports sell successfully in canada

there is a comparative advantage to the country selling to canadians

what happens if canadian exports sell successfully in the rest of the world

there is a comparative advantage to those canadian businesses

three forms of government protection of economic interest

tariffs, import quotas, and domestic subsidies

tariff

tax applied to imports

who must pay the tariff to the canadian government

the canadian business importing the product

what kind of cost is a tariff

a business cost, which is passed on to consumers, increasing the price of the product

3 reasons why tariffs are attractive to governments

1. they raise revenues for the government to spend

2. they win votes and campaign donations for politicians from businesses and workers in import-competing industries

3. they are a tax on non-canadians who don’t vote, so there is little political damage from raising tariffs

import quotas

limit on the quantity of a product or service that can be imported

what does higher prices for imported products mean

with reduced supply and restricted competition, the quantity sold in canada is less than with freer trade

impact of import quotas

there are higher prices and profits for the businesses and more jobs and higher wages for workers; canadian consumers face higher prices

subsidies to domestic producers

government payment to domestic producers of products or services

what is the most common and controversial form of protectionism

subsidies to domestic producers (usually for agricultural products)

who gains from freer international trade

a large number of consumers, but the gain is small