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Demand-side and Supply-side policies

Demand-side and Supply-side policies. Demand-side policies. Based on the idea that short-term fluctuations of Real GDP are due to actions of firms and consumers that affect AD, causing inflationary and recessionary gaps. Objectives: bring the AD to the FE level of Real GDP.

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Demand-side and Supply-side policies

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  1. Demand-side and Supply-side policies

  2. Demand-side policies • Based on the idea that short-term fluctuations of Real GDP are due to actions of firms and consumers that affect AD, causing inflationary and recessionary gaps. • Objectives: bring the AD to the FE level of Real GDP. • D-side policies can also impact on economic growth, that is, increase potential GDP (shift LRAS curve to the right). IB exam question of this year!!

  3. Fiscal Policy (FP) • Definition: manipulations by the government of its own expenditures and taxes in order to influence the level of AD. • Government receives revenues from income and business taxes, T. • Government expenditures: G • If G=T: balanced budget • If G>T: budget deficit Gov needs to borrow • If G<T: budget surplus • Public/Government Debt is the gov’s accumulation of deficits minus surpluses.

  4. FP can affect AD through 3 components: • G. Direct impact on AD • C. FP, through changes in income taxes, affects the disposable income of consumers, which affects their consumption expenditures. • I. Through changes in business taxes, FP affects the after tax profits of firms, which has an impact on their level of investment expenditures.

  5. Expansionary Fiscal Policy • In a recessionary gap (Y<YFE), the gov can increase AD with expansionary FP, which works to expand the level of economic activity. • Expansionary FP can consist of: • ↑ G • ↓ personal income taxes • ↓ business taxes • a combination of the three.

  6. An increase in G has a direct impact on AD • A decrease in T affects AD in a 2-step process: ↓T → ↑Disposable income Yd / ↑After-tax businesses profits → ↑C / ↑I →↑ AD • The increase in real GDP will be smaller in the neoclassical model than in the Keynesian one, because of the upward sloping neoclassical AS curve. • The increase in the PL will be smaller in the Keynesian model, where the increase in AD may result in no increase in the PL at all if the AD shift occurs entirely within the horizontal segment of the Keynesian AS curve.

  7. Contractionary Fiscal Policy • In a inflationary gap (Y>YFE), the gov can decrease AD with expansionary FP, which works to contract AD and the level of economic activity. • Contractionary FP can consist of: • ↓ G • ↑ personal income taxes • ↑ business taxes • a combination of the three.

  8. A decrease in G has a direct impact on AD • An increase in T affects AD in a 2-step process: ↑ T → ↓Disposable income Yd / ↓After-tax businesses profits → ↓C / ↓I → ↓ AD

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