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PowerPoint Lectures for Principles of Economics, 9e By Karl E. Case, Ray C. Fair & Sharon M. Oster PowerPoint PPT Presentation


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PowerPoint Lectures for Principles of Economics, 9e By Karl E. Case, Ray C. Fair & Sharon M. Oster. ; ; . The Government and Fiscal Policy. Prepared by:. Fernando & Yvonn Quijano. The Government and Fiscal Policy. PART V THE CORE OF MACROECONOMIC THEORY. 24. CHAPTER OUTLINE.

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PowerPoint Lectures for Principles of Economics, 9e By Karl E. Case, Ray C. Fair & Sharon M. Oster

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PowerPoint Lectures for

Principles of Economics, 9e

By

Karl E. Case, Ray C. Fair & Sharon M. Oster

; ;


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The Governmentand Fiscal Policy

Prepared by:

Fernando & Yvonn Quijano


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The Governmentand Fiscal Policy

PART VTHE CORE OF MACROECONOMIC THEORY

24

CHAPTER OUTLINE

Government in the Economy

Government Purchases (G), Net Taxes (T), and Disposable income (Yd)

The Determination of Equilibrium Output(Income)

Fiscal Policy at Work: Multiplier Effects

The Government Spending Multiplier

The Tax Multiplier

The Balanced-Budget Multiplier

The Federal BudgetThe Budget in 2007

Fiscal Policy Since 1993: The Clinton andBush Administrations

The Federal Government Debt

The Economy’s Influence on the Government Budget Tax Revenues Depend on the State of the Economy Some Government Expenditures Depend on the State of the EconomyAutomatic StabilizersFiscal DragFull-Employment Budget

Looking Ahead

Appendix A: Deriving the Fiscal PolicyMultipliers

Appendix B: The Case in Which Tax RevenuesDepend on Income


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The Government and Fiscal Policy

fiscal policy The government’s spending and taxing policies.

monetary policy The behavior of the Federal Reserve concerning the nation’s money supply.


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Government in the Economy

discretionary fiscal policy Changes in taxes or spending that are the result of deliberate changes in government policy.

Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)

net taxes (T) Taxes paid by firms and households to the government minus transfer payments made to households by the government.

disposable, or after-tax, income (Yd) Total income minus net taxes: Y - T.

disposable income ≡ total income − net taxes

Yd≡Y − T


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Government in the Economy

Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)

 FIGURE 24.1 Adding Net Taxes (T) and Government Purchases (G) to the Circular Flow of Income


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Government in the Economy

Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)

When government enters the picture, the aggregate income identity gets cut into three pieces:

And aggregate expenditure (AE) equals:


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Government in the Economy

Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)

budget deficit The difference between what a government spends and what it collects in taxes in a given period: G - T.

budget deficit ≡G − T


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Government in the Economy

Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)

Adding Taxes to the Consumption Function

To modify our aggregate consumption function to incorporate disposable income instead of before-tax income, instead of C = a + bY, we write

C = a + bYd

or

C = a + b(Y − T)

Our consumption function now has consumption depending on disposable income instead of before-tax income.


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Government in the Economy

Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)

Planned Investment

The government can affect investment behavior through its tax treatment of depreciation and other tax policies.


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Government in the Economy

The Determination of Equilibrium Output (Income)

Y = C + I + G


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Government in the Economy

The Determination of Equilibrium Output (Income)

 FIGURE 24.2 Finding Equilibrium Output/Income Graphically

Because G and I are both fixed at 100, the aggregate expenditure function is the new consumption function displaced upward by I + G = 200.

Equilibrium occurs at Y = C + I + G = 900.


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Government in the Economy

The Determination of Equilibrium Output (Income)

The Saving/Investment Approach to Equilibrium

saving/investment approach to equilibrium:

S + T = I + G

To derive this, we know that in equilibrium, aggregate output (income)(Y)equals planned aggregate expenditure (AE). By definition, AE equals C + I + G; and by definition, Y equals

C + S + T. Therefore, at equilibrium

C + S + T = C + I + G

Subtracting C from both sides leaves:

S + T = I + G


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Fiscal Policy at Work: Multiplier Effects

  • At this point, we are assuming that the government controls G and T. In this section, we will review three multipliers:

    • Government spending multiplier

    • Tax multiplier

    • Balanced-budget multiplier


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Fiscal Policy at Work: Multiplier Effects

The Government Spending Multiplier

government spending multiplier The ratio of the

change in the equilibrium level of output to a change in government spending.


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Fiscal Policy at Work: Multiplier Effects

The Government Spending Multiplier


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Fiscal Policy at Work: Multiplier Effects

The Government Spending Multiplier

 FIGURE 24.3 The Government

Spending Multiplier

Increasing government spending by 50 shifts the AE function up by 50. As Y rises in response, additional consumption is generated.

Overall, the equilibrium level of Y increases by 200, from 900 to 1,100.


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Fiscal Policy at Work: Multiplier Effects

The Tax Multiplier

tax multiplier The ratio of change in the equilibrium level of output to a change in taxes.


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Fiscal Policy at Work: Multiplier Effects

The Balanced-Budget Multiplier

balanced-budget multiplier The ratio of change in the equilibrium level of output to a change in government spending where the change in government spending is balanced by a change in taxes so as not to create any deficit. The balanced-budget multiplier is equal to 1: The change in Y resulting from the change in G and the equal change in T are exactly the same size as the initial change in G or T.


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Fiscal Policy at Work: Multiplier Effects

The Balanced-Budget Multiplier


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Fiscal Policy at Work: Multiplier Effects

The Balanced-Budget Multiplier


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The Federal Budget

federal budget The budget of the federal government.

The “budget” is really three different budgets.

First, it is a political document that dispenses favors to certain groups or regions and places burdens on others.

Second, it is a reflection of goals the government wants to achieve.

Third, the budget may be an embodiment of some beliefs about how (if at all) the government should manage the macroeconomy.


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The Federal Budget

The Budget in 2007


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The Federal Budget

The Budget in 2007

federal surplus (+) or deficit () Federal government receipts minus expenditures.


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The Federal Budget

Fiscal Policy Since 1993: The Clinton and Bush Administrations

 FIGURE 24.4 Federal Personal Income Taxes as a Percentage of Taxable Income, 1993 I–2007 IV


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The Federal Budget

Fiscal Policy Since 1993: The Clinton and Bush Administrations

 FIGURE 24.5 Federal Government Consumption Expenditures as a Percentage of GDP and Federal Transfer Payments and Grants-in-Aid as a Percentage of GDP, 1993 I–2007 IV


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The Federal Budget

Fiscal Policy Since 1993: The Clinton and Bush Administrations

 FIGURE 24.6 The Federal Government Surplus (+) or Deficit (–) as a Percentage of GDP, 1993 I–2007 IV


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The Federal Budget

The Federal Government Debt

federal debt The total amount owed by the federal government.

privately held federal debt The privately held

(non-government-owned) debt of the U.S. government.


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The Federal Budget

The Federal Government Debt

 FIGURE 24.7 The Federal Government Debt as a Percentage of GDP, 1993 I–2007 IV


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The Economy’s Influence on the Government Budget

Tax Revenues Depend on the State of the Economy

Tax revenue, on the other hand, depends on taxable income, and income depends on the state of the economy, which the government does not completely control.

Some Government Expenditures Depend on the State of the Economy

Transfer payments tend to go down automatically during an expansion.

Inflation often picks up when the economy is expanding. This can lead the government to spend more than it had planned to spend.

Any change in the interest rate changes government interest payments.


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The Economy’s Influence on the Government Budget

Fiscal Policy In 2008

Some Government Expenditures Depend on the State of the Economy

Congress Approves Economic-Stimulus Bill

Wall Street Journal


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The Economy’s Influence on the Government Budget

Automatic Stabilizers

automatic stabilizers Revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to stabilize GDP.

Fiscal Drag

fiscal drag The negative effect on the economy that occurs when average tax rates increase because taxpayers have moved into higher income brackets during an expansion.


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The Economy’s Influence on the Government Budget

Full-Employment Budget

full-employment budget What the federal budget would be if the economy were producing at the full-employment level of output.

structural deficit The deficit that remains at full employment.

cyclical deficit The deficit that occurs because of a downturn in the business cycle.


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REVIEW TERMS AND CONCEPTS

net taxes (T)

privately held federal debt

structural deficit

tax multiplier

1.Disposable income Yd≡Y − T

2.AE≡C + I + G

3.Government budget deficit ≡G − T

4.Equilibrium in an economy with government: Y = C + I + G

5.Saving/investment approach to equilibrium in an economy with government: S + T = I + G

6.Government spending multiplier ≡

7.Tax multiplier ≡

8.Balanced-budget multiplier ≡ 1

automatic stabilizers

balanced-budget multiplier

budget deficit

cyclical deficit

discretionary fiscal policy

disposable, or after-tax, income (Yd)

federal budget

federal debt

federal surplus (+) or deficit (−)

fiscal drag

fiscal policy

full-employment budget

government spending multiplier

monetary policy


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A P P E N D I X A

DERIVING THE FISCAL POLICY MULTIPLIERS

THE GOVERNMENT SPENDING AND TAX MULTIPLIERS


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increase in spending:

- decrease in spending:

= net increase in spending

A P P E N D I X A

DERIVING THE FISCAL POLICY MULTIPLIERS

THE BALANCED-BUDGET MULTIPLIER

  • The balanced-budget multiplier is found by combining the effects of government spending and taxes:

In a balanced-budget increase, ΔG = ΔT; so we can substitute:

net initial increase in spending:

ΔG − ΔG (MPC) = ΔG (1 − MPC)


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We can now apply the expenditure multiplier to this net initial increase in spending:

A P P E N D I X A

DERIVING THE FISCAL POLICY MULTIPLIERS

THE BALANCED-BUDGET MULTIPLIER

Because MPS = (1 − MPC), the net initial increase in spending is:

ΔG (MPS)


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A P P E N D I X B

THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME

 FIGURE 24B.1 The Tax Function


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A P P E N D I X B

THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME

 FIGURE 24B.2 Different Tax Systems

When taxes are strictly lump-sum (T = 100) and do not depend on income, the aggregate expenditure function is steeper than when taxes depend on income.


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A P P E N D I X B

THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME

THE GOVERNMENT SPENDING AND TAX MULTIPLIERS ALGEBRAICALLY


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