eco 6351 economics for managers chapter 12. fiscal policy prof. vera adamchik
TRANSCRIPT
![Page 1: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/1.jpg)
Eco 6351Economics for Managers
Chapter 12. Fiscal Policy
Prof. Vera Adamchik
![Page 2: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/2.jpg)
Undesired equilibrium• There is no guarantee that AD will always
produce an equilibrium at full employment and price stability.
• Sometimes there will be too little demand and sometimes there will be too much.
• Equilibrium output is not necessarily the same as the full employment level of output.
• Hence, the aggregate demand for goods and services will not always be compatible with economic stability.
![Page 3: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/3.jpg)
Inadequate Demand
SRAS
AD2
AD*AD1
a
c
bP*
Q1 QFE
REAL OUTPUT (quantity per year)
PR
ICE
LE
VE
L (a
vera
ge p
rice)
P2
Too little AD: Unemployment
Too much AD: Inflation
Q2
LRAS
![Page 4: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/4.jpg)
Components of AD• The four major components of
aggregate demand are:
– consumption expenditure (C)
– investment (I)
– government expenditure (G)
– net exports (NX = exports minus imports = X-M)
• These four components of AD sum to real GDP (see Chapter 2)
![Page 5: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/5.jpg)
Determinants of AD = C+I+G+NX
• Change in consumer spending (C):
– Consumer wealth
– Consumer expectations
– Consumer indebtedness
– Taxes
![Page 6: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/6.jpg)
Determinants of AD = C+I+G+NX
• Change in investment spending (I):
– Real interest rates
– Expected returns
• Expected future business conditions
• Technology
• Degree of excess capacity
• Business taxes
![Page 7: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/7.jpg)
Determinants of AD = C+I+G+NX
• Change in government spending (G)
• Change in net export spending (NX)
– National income abroad
– Exchange rates
![Page 8: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/8.jpg)
Fiscal Policy
The government’s attempt to influence the economy by setting and changing taxes, its purchases of goods and services (that is, government spending), and transfer payments to achieve macroeconomic objectives such as full employment, sustained long-term economics growth, and low inflation.
![Page 9: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/9.jpg)
• In the following discussion we assume a horizontal (Keynesian) segment of the SRAS curve.
![Page 10: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/10.jpg)
Pri
ce L
evel
Real Domestic Output, GDP
Q
P SRAS
AD2
Increasing Demand in the Horizontal Range
Q1 Q2
P1
AD1
![Page 11: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/11.jpg)
Pri
ce L
evel
Real Domestic Output, GDP
SRAS
AD1
Decreasing Demand in the Horizontal Range
Q2 Q1
P1
AD2
![Page 12: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/12.jpg)
Fiscal Policy Tools:
Government Spending
![Page 13: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/13.jpg)
AD1
bP1
5.6Q1
6.0QFE
aCurrent price level
REAL GDP($ trillions per year)
PR
ICE
LE
VE
L (a
vera
ge p
rice)
GDP gap
A numerical example
Full employmentEquilibrium output
LRAS
SRAS
![Page 14: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/14.jpg)
AD =GDP= C+I+G+(X-M)
5.6 tril. = 3 tril.+1 tril. + 0.9 tril. + 0.7 tril.
We would like to increase real GDP to 6 tril.
In order to increase AD, the government may increase its spending.
The question is: By how much?
![Page 15: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/15.jpg)
Disposable Income
• Disposable income is the income earned from the supply of productive services - wages, interest, rent, and profit - PLUS transfer payments from the government MINUS taxes
![Page 16: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/16.jpg)
Marginal Propensity to Consume
• The extent to which a change in disposable income changes consumption expenditure depends on the marginal propensity to consume
• The marginal propensity to consume (MPC) is the fraction of a change in disposable income that is consumed
![Page 17: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/17.jpg)
Marginal Propensity to Consume
• The marginal propensity to consume is calculated as the change in consumption expenditure divided by the change in disposable income:
![Page 18: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/18.jpg)
Marginal Propensity to Save
• The extent to which a change in disposable income changes saving depends on the marginal propensity to save
• The marginal propensity to save (MPS) is the fraction of a change in disposable income that is saved
![Page 19: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/19.jpg)
Marginal Propensities to Save
• The marginal propensity to save is calculated as the change in saving divided by the change in disposable income:
![Page 20: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/20.jpg)
Marginal Propensities to Consume and Save
• The marginal propensity to consume plus the marginal propensity to save sum to 1:
MPC + MPS = 1
![Page 21: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/21.jpg)
MPC and MPS
MPS = .25 MPC = .75
IN GOD WE
TRUST
IN GOD WE
TRUST
IN GOD WE
TRUST
IN GOD WE
TRUST
![Page 22: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/22.jpg)
Multiplier Effects
• Each dollar spent is re-spent several times.
• As a result, every dollar has a multiplied impact on aggregate expenditure.
![Page 23: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/23.jpg)
The Multiplier Process at Work
![Page 24: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/24.jpg)
The Multiplier
• The multiplier is the multiple by which an initial change in aggregate spending will alter total expenditure after an infinite number of spending cycles.
![Page 25: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/25.jpg)
The Government Expenditure Multiplier
The G Multiplier = 1/(1-MPC)
If MPC = 0.75,
The G Multiplier = 1/(1-0.75) = 4.
![Page 26: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/26.jpg)
The Ultimate Effect The ultimate change in AD after an infinite
number of spending cycles = The G multiplier * The initial change in government spending = 4 * 100 bil. = 400 bil. (that is, 0.4 tril.)
The new eqm GDP = the old eqm GDP + the ultimate change in AD = 5.6 tril. + 0.4 tril. = 6.0 tril.
![Page 27: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/27.jpg)
Q1 QF
P1
5.6 5.7 6.0
AD2 AD3
Current price level
Direct impact of rise in government spending + $100 billion
AD1
ab
REAL GDP ($ trillions per year)
PR
ICE
LE
VE
L (a
vera
ge p
rice)
Indirect impact via increased consumption + $300 billion
Multiplier EffectsLRAS
SRAS
![Page 28: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/28.jpg)
Fiscal Policy Tools:
Taxes
![Page 29: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/29.jpg)
A numerical example (cont.)
• Rather than increasing its own spending, government can cut taxes to increase consumption or investment spending.
![Page 30: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/30.jpg)
The Lump-Sum Tax Multiplier
The T Multiplier = -MPC/(1-MPC)
If MPC = 0.75,
The T Multiplier = -0.75/(1-0.75) = -3.
![Page 31: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/31.jpg)
• The new eqm GDP = the old eqm GDP + the ultimate change in AD;
• 5.6 tril. + the ultimate change in AD = 6.0 tril.;• The ultimate change in AD = 6.0 - 5.6 = 0.4 tril. (that is, 400
bil.).
![Page 32: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/32.jpg)
• The ultimate change in AD =
The T multiplier * The initial change in taxes;
• +400 bil. = -3 * the initial change in T;
• The init. change in T = 400/(-3) = -133.3 bil.;
• That is, the government should decrease taxes by 133.3 bil.
![Page 33: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/33.jpg)
Multiplier and Price Level
![Page 34: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/34.jpg)
Pri
ce L
evel
Real Domestic Output, GDP
Q
P SRAS
AD2
Increasing Demand in the Horizontal Range
Q1 Q2
P1
AD1
![Page 35: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/35.jpg)
Inflation Worries
• Whenever the aggregate supply curve is upward sloping an increase in aggregate demand increases prices as well as output.
• Whenever the aggregate supply curve is vertical an increase in aggregate demand increases prices but has no impact on output.
![Page 36: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/36.jpg)
Pri
ce L
evel
Real Domestic Output, GDP
Q
P SRAS
AD4
Increasing Demand in the Intermediate Range
Q3 Q4
P3
AD3
P4
![Page 37: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/37.jpg)
Pri
ce L
evel
Real Domestic Output, GDP
Q
P SRAS
AD6
Increasing Demand in the Vertical Range
Qconstant
P5
AD5
P6
![Page 38: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/38.jpg)
Pri
ce L
evel
Real Domestic Output, GDP
SRAS
AD2
Inflation and the Multiplier
GDP1 GDP2
P1
AD1
AD3
GDP3
P2
Full MultiplierEffect Reduced
MultiplierEffect Dueto Inflation
![Page 39: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/39.jpg)
Fiscal Guidelines
• The fiscal strategy for attaining the goal of full employment is to shift the aggregate demand curve
![Page 40: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/40.jpg)
Fiscal Guidelines
• Problem: insufficient demand
• Solution: increase AD• Methods:
– increase government spending,
– cut taxes,– increase transfer
payments.
• Problem: excess demand
• Solution: decrease AD• Methods:
– decrease government spending,
– raise taxes,– decrease transfer
payments.
![Page 41: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/41.jpg)
Government Budget
![Page 42: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/42.jpg)
Government Budget
• Governments:
– collect taxes, T
– spend G on goods and services
– Budget deficit: if G > T
– Budget surplus: if G < T
![Page 43: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/43.jpg)
Unbalanced Budgets
• The use of fiscal policy to manage aggregate demand implies that the budget will often be unbalanced.
![Page 44: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/44.jpg)
Budget Deficit
• Budget deficit: if G > T
• The government borrows money to pay for deficit spending.
![Page 45: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/45.jpg)
Budget Deficit
• The federal government ran significant budget deficits between 1970 and 1997.
• The deficit peaked at nearly $300 billion in 1992.
![Page 46: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/46.jpg)
Budget Surplus
• Budget surplus: if G < T
• By 1998, a combination of growing tax revenues and slower government spending created a budget surplus.
![Page 47: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/47.jpg)
Unbalanced Budgets
• In Keynes’ view, an unbalanced budget is perfectly appropriate if macro conditions call for a deficit or surplus.
![Page 48: Eco 6351 Economics for Managers Chapter 12. Fiscal Policy Prof. Vera Adamchik](https://reader035.vdocuments.net/reader035/viewer/2022062321/56649e575503460f94b4fa40/html5/thumbnails/48.jpg)