TheEffectsofFiscalPolicyonRealGDPandthePriceLevel16.2LEARNINGOBJECTIVEExplainhowfiscalpolicyaffectsaggregatedemandandhowthegovernmentcanusefiscalpolicytostabilizetheeconomy.@2015PearsonEducafion,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 11 The Effects of Fiscal Policy on Real GDP and the Price Level 16.2 Explain how fiscal policy affects aggregate demand and how the government can use fiscal policy to stabilize the economy
ExpansionaryFiscalPolicyintheAD-ASModelLong-runExpansionaryfiscal policyaggregateExpansionaryfiscalsupply,LRASinvolves increasingpolicycausesPricelevelShort-runtheADcurveto(GDPdeflator,governmentpurchases oraggregateshifttotheright2009=100)supply,SRASdecreasing taxes..Increasing governmentpurchases directly110increases aggregate108demand.DecreasingtaxesindirectlyAD2Aggregateaffects aggregatedemanddemand,AD,byincreasingdisposableReal GDP0$17.217.4(trillionsof2009dollars)income, and hence(a)Expansionaryfiscal policyconsumption spendingFigure 16.5aFiscal policyIfthegovernmentbelievesrealGDPwillbebelowpotentialGDP,itcanenactexpansionaryfiscalpolicyinanattempttorestorelongrun equilibriumdecreasing unemployment.122015PearsonEducation,nc
© 2015 Pearson Education, Inc. 12 Expansionary Fiscal Policy in the AD-AS Model Expansionary fiscal policy involves increasing government purchases or decreasing taxes. • Increasing government purchases directly increases aggregate demand. • Decreasing taxes indirectly affects aggregate demand by increasing disposable income, and hence consumption spending. If the government believes real GDP will be below potential GDP, it can enact expansionary fiscal policy in an attempt to restore longrun equilibrium—decreasing unemployment. Figure 16.5a Fiscal policy
ContractionaryFiscal PolicyintheAD-ASModelContractionaryfiscalLong-runpolicycausesContractionaryfiscalpolicyaggregatetheADcurvetosupply,LRASshifttothe leftPrice levelinvolves decreasingShort-run(GDP deflator,aggregate2009=100)governmentpurchasesorsupply,SRASincreasing taxes.112This works just like110expansionaryfiscalpolicyonlyinreverse.Aggregatedemand,AD,AD20$17.417.6RealGDP(trillionsof2009dollars)(b)ContractionaryfiscalpolicyFigure 16.5bFiscal policyIfthegovernmentbelievesrealGDPwillbeabovepotentialGDP,itcan enact contractionary fiscal policy in an attempt to restore longruneguilibrium-decreasinginflation13@2015PearsonEducation.lnc
© 2015 Pearson Education, Inc. 13 Contractionary Fiscal Policy in the AD-AS Model Contractionary fiscal policy involves decreasing government purchases or increasing taxes. • This works just like expansionary fiscal policy, only in reverse. If the government believes real GDP will be above potential GDP, it can enact contractionary fiscal policy in an attempt to restore longrun equilibrium—decreasing inflation. Figure 16.5b Fiscal policy
Summarizing Fiscal PolicyActionsbyCongressProblemResultTypeofPolicyandthePresidentRecessionExpansionaryRealGDPandthepriceIncreasegovernmentlevelrise.spendingorcuttaxesRising inflationReal GDPandthepriceContractionaryDecreasegovernmentlevelfall.spendingorraisetaxesTable 16.1Countercyclical fiscalpolicyThe federal government's actions described on the previous slidesconstitute a countercyclical fiscal policyBear in mind that:.The effects described assume ceteris paribus:everything else isstaying the same, including monetary policy.: Contractionary fiscal policy is not really causing prices to fall; it'scausing inflation to be lower than it otherwise would have been.14@2015PearsonEducafion.lnc
© 2015 Pearson Education, Inc. 14 Summarizing Fiscal Policy The federal government’s actions described on the previous slides constitute a countercyclical fiscal policy. Bear in mind that: • The effects described assume ceteris paribus: everything else is staying the same, including monetary policy. • Contractionary fiscal policy is not really causing prices to fall; it’s causing inflation to be lower than it otherwise would have been. Table 16.1 Countercyclical fiscal policy Problem Type of Policy Actions by Congress and the President Result Recession Expansionary Increase government spending or cut taxes Real GDP and the price level rise. Rising inflation Contractionary Decrease government spending or raise taxes Real GDP and the price level fall
Fiscal Policyin the Dynamic Aggregate Demand andAggregateSupplyModel16.3LEARNINGOBJECTIVEUse the dynamic aggregate demand and aggregate supply model to analyzefiscal policy.15@2015PearsonEducafion,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 15 Fiscal Policy in the Dynamic Aggregate Demand and Aggregate Supply Model 16.3 Use the dynamic aggregate demand and aggregate supply model to analyze fiscal policy