Chapter 16 Fiscal policy

Macro Economics

Fiscal policy

refers to changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives.

automatic stabilizers

government programs that automatically adjust to economic conditions to stabilize income and consumption.

Discretionary fiscal policy

refers to intentional actions the government takes to change spending or taxes

Explain how fiscal policy affects aggregate demand and how the government can use fiscal policy to stabilize the economy.

Congress and the president carry out fiscal policy through:

•Changes in government purchases

•Changes in taxes

A change in government purchases directly affects aggregate demand.

A change in taxes changes income; this in turn affects consumption, and so it has an indirect effect on aggregate demand.

expansionary fiscal policy

involves increasing government purchases or decreasing taxes.

contractionary fiscal policy

involves decreasing government purchases or increasing taxes.

countercyclical fiscal policy

a strategy of increasing government spending or decreasing taxes during economic downturns, and decreasing spending or increasing taxes during economic upswings to stabilize the economy.

ceteris paribus

"all other things being equal"; an assumption used in economics to isolate the effect of one variable on another.

dynamic aggregate demand and aggregate supply model.

a framework used to analyze the effects of economic policies and external shocks on the economy over time, incorporating expectations and adjustments in aggregate demand and supply.

multiplier effect

The process by which a change in autonomous expenditure leads to a larger change in real G D P.

Government purchase multiplier

= change in equilibrium real GDP/ change in government purchases

Tax multiplier

= change in equilibrium real GDP/ change in taxes

Transfer payment multiplier

= change in equilibrium real GDP/change in transfer payments

Timing fiscal policy is harder due to

–Legislative delay: Congress needs to agree on the actions.

–Implementation delay: Large spending projects may take months or even years to begin, even once approved.

crowding out

a decline in private expenditures as a result of an increase in government purchases

budget deficit

is the situation in which the governemnt’s expednditures are less than its tax revenue

budget surplus

is the situation in which the government’s expenditures are less than its revenue

cyclically adjusted budget deficit or surplus

the deficit or surplus in the federal government’s budget if the economy were at potential GDP

Real GDP

= hours worked *(Real GDP/hours worked)

Growth Rate of rela GDP

= growth rate of hours worked+Growth rate of labor productivity

posttax wage

the wage received by workers after taxes have been deducted, reflecting the actual income available for spending or saving.

pretax wage

the wage paid to workers before any taxes are deducted, representing the gross income earned by employees.

tax wedge

the difference between the total labor cost to employers and the net take-home pay for employees, influenced by taxes and social security contributions.

distorts the incentives

for individuals and businesses in making economic decisions, often leading to less efficient resource allocation.

Individual income tax

•Affects labor supply decisions and returns to entrepreneurship

corporate income tax

•Affects the incentives of firms to engage in investment.

tax on dividends and capital gains

•Affects the supply of loanable funds from households to firms and hence the real interest rate.

•Also affects the way firms disburse profits—2003 reduction in dividend tax led some firms like Microsoft to pay dividends for the first time.

Trump administration policies for this included:

•Reducing business taxes to increase investment spending

•Increasing business startups by reducing regulations and taxes on small businesses

consumption function

C=2,000+0.75(Y-T)

Planned investment function

I=2,000

Government purchases function

G=2,500

Tax Function

T=2,000

Equilibrium conditon

Y=C+I+G

Disposable Income

(Y-T)

Marginal propensity to consume MPC

0.75

Consumption function

C=C+MPC(Y-T)

Planned investment function

I=I

Government purchases function

G=G

Tax function

T=T

Equilibrium condition

Y=C=I+G