Monetary and Fiscal Policy, Macroeconomic Fluctuations, and Macroeconomic Equilibrium
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Unit9Assignmenthelp.pptxAB204/BU204. Week 9. Assignment.
New W9 Assignment
Rod Biasca
2018
Copyright © 2004 South-Western
Expansionary Fiscal Policy –
Increases in government expenditures and/or decreases in taxes to achieve particular economic goals.
Contractionary Fiscal Policy –
Decreases in government expenditures and/or increases in taxes to achieve particular economic goals.
Discretionary Fiscal Policy-
Deliberate changes of government expenditures and/or taxes to achieve particular economic goals.
Automatic Fiscal Policy –
Changes in government expenditures and/or taxes that occur automatically without (additional) congressional action.
Fiscal Policy
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Week 9. Question 1.
a. There is a decrease in households’ wealth due to a decline in the stock market .
b. The government lowers taxes, leaving households with more disposable income, with no corresponding reduction in government purchases
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Table 12.1 Krugman and Wells: Macroeconomics, Second Edition Copyright © 2009 by Worth Publishers
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W9 Assignment. Q1a.
a. There is a decrease in households’ wealth due to a decline in the stock market.
A decrease in households’ wealth will reduce consumer spending. Beginning at long-run macroeconomic equilibrium, E1 in the accompanying diagram, the aggregate demand curve will shift from AD1 to AD2. In the short run, nominal wages are sticky, and the economy will be in short-run macroeconomic equilibrium at point E2. The aggregate price level will be lower than at E1, and aggregate output will be lower than potential output.
The economy faces a recessionary gap. As wage contracts are renegotiated, nominal wages will fall and the short-run aggregate supply curve will shift gradually to the right over time until it reaches SRAS2 and intersects AD2 at point E3. At E3, the economy is back at its potential output but at a much lower aggregate price level.
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Negative Demand Shock
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In the long run, the economy is self-correcting: demand shocks have only temporary effects on aggregate output. Starting at E1, a negative demand shock shifts AD1 leftward to AD2. In the short run, the economy moves to E2 and a recessionary gap arises: the aggregate price level declines from P1 to P2, aggregate output declines from Y1 to Y2, and unemployment rises. But in the long run, nominal wages fall in response to high unemployment, and SRAS1 shifts rightward to SRAS2: aggregate output rises from Y2 to Y1, and the aggregate price level declines again, from P2 to P3. Long-run macroeconomic equilibrium is eventually restored at E3.
W9. Assignment. Question 1a.
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Expansionary Fiscal Policy
can Close a Recessionary Gap
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At E1 the economy is in short-run equilibrium where the aggregate demand curve AD1 intersects the SRAS curve. At E1, there is a recessionary gap of YE − Y1. An expansionary fiscal policy—an increase in government purchases, a reduction in taxes, or an increase in government transfers—shifts the aggregate demand curve rightward. It can close the recessionary gap by shifting AD1 to AD2, moving the economy to a new short-run equilibrium, E2, which is also a long-run equilibrium.
Expansionary Fiscal Policy
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Real GDP
Price Level
D0
D0
S
S
D1
D1
A
E
Rise in
real GDP
Rise in
Price level
W9 Assignment. Q1b.
b. The government lowers taxes, leaving households with more disposable income, with no corresponding reduction in government purchases.
An increase in disposable income will increase consumer spending; at any given aggregate price level, the aggregate demand curve will shift to the right.
Beginning at long-run macroeconomic equilibrium E1 in the accompanying diagram, the aggregate demand curve will shift from AD1 to AD2. In the short run, nominal wages are sticky, and the economy will be in short-run macroeconomic equilibrium at point E2. The aggregate price level is higher than at E1, and aggregate output will be higher than potential output.
The economy faces an inflationary gap. As wage contracts are renegotiated, nominal wages will rise and the short-run aggregate supply curve will shift gradually to the left over time until it reaches SRAS2 and intersects AD2 at point E3. At E3, the economy is back at its potential output but at a much higher aggregate price level.
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Shifts of Aggregate Demand: Short-Run Effects
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A demand shock shifts the aggregate demand curve, moving the aggregate price level and aggregate output in the same direction. In panel (a) a negative demand shock shifts the aggregate demand curve leftward from AD1 to AD2, reducing the aggregate price level from P1 to P2 and aggregate output from Y1 to Y2.
In panel (b) a positive demand shock shifts the AD curve to the right, increasing the aggregate price level from P1 to P2 and aggregate output from Y1 to Y2.
W9 Assignment. Q1b.
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Week 9. Assignment. Question 2. Fiscal Policies.
2. An economy in a hypothetical country is in long-run macroeconomic equilibrium when each of the following aggregate demand shocks occurs. What kind of gap—inflationary or recessionary—will the economy face after the shock, and what type of fiscal policies, giving specific examples, would help move the economy back to potential output?
a. A stock market boom increases the value of stocks held by households
b. The government increases its purchases (spending) due to natural disasters
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Table 12.1 Krugman and Wells: Macroeconomics, Second Edition Copyright © 2009 by Worth Publishers
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W9 Assignment. Q2a and b.
An economy is in long-run macroeconomic equilibrium when each of the following aggregate demand shocks occurs. What kind of gap — inflationary or recessionary — will the economy face after the shock, and what type of fiscal policies would help move the economy back to potential output?
a. A stock market boom increases the value of stocks held by households.
As the stock market booms and the value of stocks held by households increases, there will be an increase in consumer spending; this will shift the aggregate demand curve to the right. The economy will face an inflationary gap.
Policy makers could use contractionary fiscal policies to move the economy back to potential output.
c. The government increases its purchases (spending) due to natural disasters
If the government increases its purchases , the aggregate demand curve will shift to the right. The economy will face an inflationary gap. Policy makers could use contractionary fiscal policies to move the economy back to potential output. The government would need to reduce its purchases of other goods and services, raise taxes or reduce transfers.
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W9 Assignment. Question 2.
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Q2. Contractionary Fiscal Policy
can Eliminate an Inflationary Gap
Contractionary fiscal policy reduces aggregate demand.
Inflationary gap
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Contractionary Fiscal Policy Can Eliminate an Inflationary Gap
At E1 the economy is in short-run equilibrium where the aggregate demand curve AD1 intersects the SRAS curve. At E1, there is an inflationary gap of Y1 − YE . A contractionary fiscal policy—reduced government purchases, an increase in taxes, or a reduction in government transfers—shifts the aggregate demand curve leftward. It can close the inflationary gap by shifting AD1 to AD2, moving the economy to a new short-run equilibrium, E2, which is also a long-run equilibrium.
Fiscal Policy. Q2.The Government and the Inflationary Gaps
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W9 Assignment. Q2. Other alternatives.
An economy is in long-run macroeconomic equilibrium when each of the following aggregate demand shocks occurs. What kind of gap — inflationary or recessionary — will the economy face after the shock, and what type of fiscal policies would help move the economy back to potential output?
Firms come to believe that a recession in the near future is likely.
If firms become concerned about a recession in the near future, they will decrease investment spending and aggregate demand will shift to the left. The economy will face a recessionary gap.
Policy makers could use expansionary fiscal policies to move the economy back to potential output.
The quantity of money in the economy declines and interest rates increase.
As interest rates rise, investment spending will decrease and the aggregate demand curve will shift to the left. The economy will face a recessionary gap.
Policy makers could use expansionary fiscal policies to move the economy back to potential output.
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