CHAPTER 24 The Government and Fiscal Policy Power

CHAPTER 24 The Government and Fiscal Policy Power. Point Lectures for Principles of Economics, 9 e ; ; By Karl E. Case, Ray C. Fair & Sharon M. Oster © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 1 of 63

CHAPTER 24 The Government and Fiscal Policy © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 2 of 63

PART V THE CORE OF MACROECONOMIC THEORY 24 The Government and Fiscal Policy Prepared by: Fernando & Yvonn Quijano © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster

PART V THE CORE OF MACROECONOMIC THEORY The Government and Fiscal Policy 24 CHAPTER OUTLINE Government in the Economy CHAPTER 24 The Government and Fiscal Policy 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 Budget The Budget in 2007 Fiscal Policy Since 1993: The Clinton and Bush 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 Economy Automatic Stabilizers Fiscal Drag Full-Employment Budget Looking Ahead Appendix A: Deriving the Fiscal Policy Multipliers Appendix B: The Case in Which Tax Revenues Depend on Income © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 4 of 63

The Government and Fiscal Policy CHAPTER 24 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 5 of 63

CHAPTER 24 The Government and Fiscal Policy The behavior of the Federal Reserve concerning the nation’s money supply is called: a. Discretionary fiscal policy. b. Automatic fiscal policy. c. Budgetary policy. d. Monetary policy. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 6 of 63

CHAPTER 24 The Government and Fiscal Policy The behavior of the Federal Reserve concerning the nation’s money supply is called: a. Discretionary fiscal policy. b. Automatic fiscal policy. c. Budgetary policy. d. Monetary policy. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 7 of 63

Government in the Economy CHAPTER 24 The Government and Fiscal Policy 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 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 8 of 63

CHAPTER 24 The Government and Fiscal Policy Over which of the following categories does the government have more control? a. Tax revenue. b. Government expenditures. c. Tax rates. d. The size of corporate profits. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 9 of 63

CHAPTER 24 The Government and Fiscal Policy Over which of the following categories does the government have more control? a. Tax revenue. b. Government expenditures. c. Tax rates. d. The size of corporate profits. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 10 of

Government in the Economy Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) CHAPTER 24 The Government and Fiscal Policy FIGURE 24. 1 Adding Net Taxes (T) and Government Purchases (G) to the Circular Flow of Income © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 11 of

CHAPTER 24 The Government and Fiscal Policy Select the best answer. Households use their disposable income (Yd) to do the following: a. Consume. b. Consume and save. c. Consume, save, and pay taxes. d. Consume, save, pay taxes, and buy imports. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 12 of

CHAPTER 24 The Government and Fiscal Policy Select the best answer. Households use their disposable income (Yd) to do the following: a. Consume. b. Consume and save. c. Consume, save, and pay taxes. d. Consume, save, pay taxes, and buy imports. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 13 of

Government in the Economy Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) CHAPTER 24 The Government and Fiscal Policy When government enters the picture, the aggregate income identity gets cut into three pieces: And aggregate expenditure (AE) equals: © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 14 of

Government in the Economy CHAPTER 24 The Government and Fiscal Policy 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 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 15 of

Government in the Economy Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) CHAPTER 24 The Government and Fiscal Policy Adding Taxes to the Consumption Function To modify our aggregate consumption function to incorporate disposable income instead of beforetax income, instead of C = a + b. Y, we write C = a + b. Yd or C = a + b(Y − T) Our consumption function now has consumption depending on disposable income instead of before -tax income. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 16 of

CHAPTER 24 The Government and Fiscal Policy When government enters the circular flow of income, which of the following is an expression for planned aggregate expenditure? a. Y−T b. C+S+T c. C+I+G d. G–T © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 17 of

CHAPTER 24 The Government and Fiscal Policy When government enters the circular flow of income, which of the following is an expression for planned aggregate expenditure? a. Y−T b. C+S+T c. C+I+G d. G–T © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 18 of

Government in the Economy Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) CHAPTER 24 The Government and Fiscal Policy Planned Investment The government can affect investment behavior through its tax treatment of depreciation and other tax policies. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 19 of

Government in the Economy The Determination of Equilibrium Output (Income) Y=C+I+G CHAPTER 24 The Government and Fiscal Policy TABLE 24. 1 Finding Equilibrium for I = 100, G = 100, and T = 100 (1) Output (Income) Y 300 500 700 900 1, 100 1, 300 1, 500 (2) (3) (4) (5) Net Disposable Consumption Saving Taxes Income Spending S Yd / Y T (C = 100 +. 75 Yd) (Yd – C) T 100 100 200 400 600 800 1, 000 1, 200 1, 400 250 400 550 700 850 1, 000 1, 150 - 50 0 50 100 150 200 250 (6) (7) Planned Investment Government Spending Purchases I G 100 100 100 100 (8) (9) (10) Planned Aggregate Expenditure C+I+G Unplanned Inventory Change Y (C + I + G) Adjustment to Disequilibrium 450 600 750 900 1, 050 1, 200 1, 350 - 100 - 50 0 + 50 + 100 + 150 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster Output 8 Equilibrium Output 20 of

Government in the Economy The Determination of Equilibrium Output (Income) CHAPTER 24 The Government and Fiscal Policy 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 21 of

Government in the Economy The Determination of Equilibrium Output (Income) The Saving/Investment Approach to Equilibrium CHAPTER 24 The Government and Fiscal Policy 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 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 22 of

CHAPTER 24 The Government and Fiscal Policy In the circular flow that includes households, firms, and government, which of the following expressions is the leakages/injections approach to equilibrium? a. Y = C + I + G. b. C + S = I + G. c. Y = a + b. T + I + G. d. S + T = I + G. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 23 of

CHAPTER 24 The Government and Fiscal Policy In the circular flow that includes households, firms, and government, which of the following expressions is the leakages/injections approach to equilibrium? a. Y = C + I + G. b. C + S = I + G. c. Y = a + b. T + I + G. d. S + T = I + G. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 24 of

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: CHAPTER 24 The Government and Fiscal Policy Government spending multiplier Tax multiplier Balanced-budget multiplier © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 25 of

Fiscal Policy at Work: Multiplier Effects CHAPTER 24 The Government and Fiscal Policy The Government Spending Multiplier government spending multiplier The ratio of the change in the equilibrium level of output to a change in government spending. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 26 of

Fiscal Policy at Work: Multiplier Effects The Government Spending Multiplier TABLE 24. 2 Finding Equilibrium After a Government Spending Increase of 50 (G Has Increased from 100 in Table 24. 1 to 150 Here) CHAPTER 24 The Government and Fiscal Policy (1) Output (Income) Y (2) (3) (4) (5) Net Disposable Consumption Saving Taxes Income Spending S Yd / Y T (C = 100 +. 75 Yd) (Yd – C) T (6) (7) Planned Investment Government Spending Purchases I G (8) (9) (10) Planned Unplanned Aggregate Inventory Adjustment Expenditure Change To C + I + G Y (C + I + G) Disequilibrium 300 100 250 - 50 100 150 500 - 200 Output 8 500 100 400 0 100 150 650 - 150 Output 8 700 100 600 550 50 100 150 800 - 100 Output 8 900 100 800 700 100 150 950 - 50 Output 8 1, 100 1, 000 850 100 150 1, 100 0 1, 300 1, 200 1, 000 200 150 1, 250 + 50 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster Equilibrium Output 27 of

CHAPTER 24 The Government and Fiscal Policy How much of an increase in government spending would be required to generate a $200 billion increase in the equilibrium level of output? a. An amount less than $200 billion in government spending. b. An amount greater than $200 billion in government spending. c. Exactly $200 billion in government spending. d. None of the above. Equilibrium output does not change with changes in government spending. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 28 of

CHAPTER 24 The Government and Fiscal Policy How much of an increase in government spending would be required to generate a $200 billion increase in the equilibrium level of output? a. An amount less than $200 billion in government spending. b. An amount greater than $200 billion in government spending. c. Exactly $200 billion in government spending. d. None of the above. Equilibrium output does not change with changes in government spending. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 29 of

Fiscal Policy at Work: Multiplier Effects The Government Spending Multiplier CHAPTER 24 The Government and Fiscal Policy 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 30 of

Fiscal Policy at Work: Multiplier Effects The Tax Multiplier CHAPTER 24 The Government and Fiscal Policy tax multiplier The ratio of change in the equilibrium level of output to a change in taxes. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 31 of

CHAPTER 24 The Government and Fiscal Policy Which of the following formulas shows the impact of a change in taxes on equilibrium income? a. Y = a + b(Y – T) + I + G b. Y = 1/(1 – b) * (a – b. T + I + G) c. S+T=I+G d. – ∆T * (b/1 – b) e. C+S=I+G © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 32 of

CHAPTER 24 The Government and Fiscal Policy Which of the following formulas shows the impact of a change in taxes on equilibrium income? a. Y = a + b(Y – T) + I + G b. Y = 1/(1 – b) * (a – b. T + I + G) c. S+T=I+G d. – ∆T * (b/1 – b) e. C+S=I+G © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 33 of

Fiscal Policy at Work: Multiplier Effects CHAPTER 24 The Government and Fiscal Policy 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 34 of

Fiscal Policy at Work: Multiplier Effects The Balanced-Budget Multiplier TABLE 24. 3 Finding Equilibrium After a Balanced-Budget Increase in G and T of 200 Each (Both G and T Have Increased from 100 in Table 24. 1 to 300 Here) CHAPTER 24 The Government and Fiscal Policy (1) Output (Income) Y (2) (3) (4) Net Disposable Consumption Taxes Income Spending Yd / Y T (C = 100 +. 75 Yd) T (5) (6) (7) (8) (9) Planned Investment Spending I Government Purchases G Planned Aggregate Expenditure C+I+G Unplanned Inventory Change Y (C + I + G) Adjustment To Disequilibrium 500 300 250 100 300 650 - 150 Output 8 700 300 400 100 300 800 - 100 Output 8 900 300 600 550 100 300 950 - 50 Output 8 1, 100 300 800 700 100 300 1, 100 0 1, 300 1, 000 850 100 300 1, 250 + 50 Output 1, 500 300 1, 200 1, 000 100 300 1, 400 + 100 Output © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster Equilibrium 35 of

CHAPTER 24 The Government and Fiscal Policy What happens when there is a simultaneous increase in government spending of $100 and a lump-sum tax of $100? a. Equilibrium income would increase by $100, or the amount of increase in G. b. Equilibrium income would decrease by $100, or the amount of increase in T. c. Equilibrium income would decrease by $200, or double the amount of the increase in T. d. Nothing happens. Equilibrium income remains the same because the amount of government spending (G) is compensated by the amount of taxation (T). © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 36 of

CHAPTER 24 The Government and Fiscal Policy What happens when there is a simultaneous increase in government spending of $100 and a lump-sum tax of $100? a. Equilibrium income would increase by $100, or the amount of increase in G. b. Equilibrium income would decrease by $100, or the amount of increase in T. c. Equilibrium income would decrease by $200, or double the amount of the increase in T. d. Nothing happens. Equilibrium income remains the same because the amount of government spending (G) is compensated by the amount of taxation (T). © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 37 of

Fiscal Policy at Work: Multiplier Effects The Balanced-Budget Multiplier TABLE 24. 4 Summary of Fiscal Policy Multipliers CHAPTER 24 The Government and Fiscal Policy Stimulus Government spending multiplier Increase or decrease in the level of government purchases: ∆G Tax multiplier Increase or decrease in the level of net taxes: ∆T Balanced-budget multiplier Simultaneous balanced-budget increase or decrease in the level of government purchases and net taxes: ∆G = ∆T Multiplier Final Impact On Equilibrium Y 1 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 38 of

The Federal Budget CHAPTER 24 The Government and Fiscal Policy 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 39 of

The Federal Budget CHAPTER 24 The Government and Fiscal Policy The Budget in 2007 TABLE 24. 5 Federal Government Receipts and Expenditures, 2007 (Billions of Dollars) Amount Percentage Of Total Receipts Personal income taxes 1, 162. 1 43. 5 Excise taxes and customs duties 99. 9 3. 7 Corporate income taxes 380. 8 14. 3 Taxes from the rest of the world 13. 4 0. 5 Contributions for social insurance 953. 0 35. 7 Interest receipts and rents and royalties 25. 1 0. 9 Current transfer receipts from business and persons 39. 4 1. 5 Current surplus of government enterprises − 2. 3 − 0. 0 Total 2, 671. 4 100. 0 Current Expenditures Consumption expenditures 856. 0 29. 6 Transfer payments to persons 1, 270. 7 43. 9 Transfer payments to the rest of the world 38. 6 1. 3 Grants-in-aid to state and local governments 377. 5 13. 1 Interest payments 302. 4 10. 5 Subsidies 46. 7 1. 6 Total 2, 892. 0 100. 0 Net federal government saving—surplus (+) or deficit (−) − 220. 6 (Total current receipts − Total current expenditures) Source: U. S. Department of Commerce, Bureau of Economic Analysis. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 40 of

The Federal Budget The Budget in 2007 CHAPTER 24 The Government and Fiscal Policy federal surplus (+) or deficit ( ) Federal government receipts minus expenditures. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 41 of

The Federal Budget CHAPTER 24 The Government and 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 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 42 of

The Federal Budget CHAPTER 24 The Government and 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 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 43 of

The Federal Budget CHAPTER 24 The Government and 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 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 44 of

CHAPTER 24 The Government and Fiscal Policy The federal budget can be conceived as: a. A political document that dispenses favors to some groups and places burdens on others. b. A reflection of goals the government wants to achieve. c. An embodiment of some beliefs about how (if at all) the government should manage the macroeconomy. d. All of the above. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 45 of

CHAPTER 24 The Government and Fiscal Policy The federal budget can be conceived as: a. A political document that dispenses favors to some groups and places burdens on others. b. A reflection of goals the government wants to achieve. c. An embodiment of some beliefs about how (if at all) the government should manage the macroeconomy. d. All of the above. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 46 of

The Federal Budget The Federal Government Debt CHAPTER 24 The Government and Fiscal Policy 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 47 of

The Federal Budget CHAPTER 24 The Government and Fiscal Policy The Federal Government Debt FIGURE 24. 7 The Federal Government Debt as a Percentage of GDP, 1993 I– 2007 IV © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 48 of

The Economy’s Influence on the Government Budget Tax Revenues Depend on the State of the Economy CHAPTER 24 The Government and Fiscal Policy 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 49 of

CHAPTER 24 The Government and Fiscal Policy After a large deficit buildup in the 1980 s, the federal government deficit: a. Continued to worsen steadily throughout the 1990 s and into the 2000 s. b. Turned into a surplus during the two Clinton administrations. c. Was vastly diminished during the G. W. Bush administration. d. Was an even larger deficit, as a percent of GDP, in 2003 than it was in 1983. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 50 of

CHAPTER 24 The Government and Fiscal Policy After a large deficit buildup in the 1980 s, the federal government deficit: a. Continued to worsen steadily throughout the 1990 s and into the 2000 s. b. Turned into a surplus during the two Clinton administrations. c. Was vastly diminished during the G. W. Bush administration. d. Was an even larger deficit, as a percent of GDP, in 2003 than it was in 1983. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 51 of

The Economy’s Influence on the Government Budget Some Government Expenditures Depend on the State of the Economy CHAPTER 24 The Government and Fiscal Policy In 2008 Congress Approves Economic-Stimulus Bill Wall Street Journal © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 52 of

The Economy’s Influence on the Government Budget Automatic Stabilizers CHAPTER 24 The Government and Fiscal Policy 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 53 of

CHAPTER 24 The Government and Fiscal Policy Which of the following statements is correct about the government’s control over its budget? a. The government has complete control over the revenue side of the budget, but not complete control over the expenditure side. b. The government has complete control over the expenditure side of the budget, but not complete control over the revenue side. c. The government does not have complete control of either the revenue side or the expenditure side of the budget. d. The size of the government budget, and whether it is in surplus or deficit, is controlled entirely by Congress, not by the economy. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 54 of

CHAPTER 24 The Government and Fiscal Policy Which of the following statements is correct about the government’s control over its budget? a. The government has complete control over the revenue side of the budget, but not complete control over the expenditure side. b. The government has complete control over the expenditure side of the budget, but not complete control over the revenue side. c. The government does not have complete control of either the revenue side or the expenditure side of the budget. d. The size of the government budget, and whether it is in surplus or deficit, is controlled entirely by Congress, not by the economy. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 55 of

The Economy’s Influence on the Government Budget Full-Employment Budget CHAPTER 24 The Government and Fiscal Policy full-employment budget What the federal budget would be if the economy were producing at the fullemployment 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 56 of

CHAPTER 24 The Government and Fiscal Policy When the economy reaches full employment, the budget deficit is: a. A combination of cyclical and structural deficits. b. Zero. c. Equal to the cyclical deficit. d. Equal to the structural deficit. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 57 of

CHAPTER 24 The Government and Fiscal Policy When the economy reaches full employment, the budget deficit is: a. A combination of cyclical and structural deficits. b. Zero. c. Equal to the cyclical deficit. d. Equal to the structural deficit. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 58 of

CHAPTER 24 The Government and Fiscal Policy REVIEW TERMS AND CONCEPTS 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 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 © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 59 of

APPENDIX A DERIVING THE FISCAL POLICY MULTIPLIERS CHAPTER 24 The Government and Fiscal Policy THE GOVERNMENT SPENDING AND TAX MULTIPLIERS © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 60 of

APPENDIX A DERIVING THE FISCAL POLICY MULTIPLIERS THE BALANCED-BUDGET MULTIPLIER CHAPTER 24 The Government and Fiscal Policy The balanced-budget multiplier is found by combining the effects of government spending and taxes: increase in spending: - decrease in spending: = net increase in spending In a balanced-budget increase, ΔG = ΔT; so we can substitute: net initial increase in spending: ΔG − ΔG (MPC) = ΔG (1 − MPC) © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 61 of

APPENDIX A DERIVING THE FISCAL POLICY MULTIPLIERS THE BALANCED-BUDGET MULTIPLIER CHAPTER 24 The Government and Fiscal Policy Because MPS = (1 − MPC), the net initial increase in spending is: ΔG (MPS) We can now apply the expenditure multiplier to this net initial increase in spending: © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 62 of

APPENDIX B THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME CHAPTER 24 The Government and Fiscal Policy FIGURE 24 B. 1 The Tax Function © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 63 of

APPENDIX B CHAPTER 24 The Government and Fiscal Policy THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME FIGURE 24 B. 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. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 64 of

APPENDIX B THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME CHAPTER 24 The Government and Fiscal Policy THE GOVERNMENT SPENDING AND TAX MULTIPLIERS ALGEBRAICALLY © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9 e by Case, Fair and Oster 65 of