Unit Three Macroeconomic Equilibrium Goals Identify inflationary and
Unit Three: Macroeconomic Equilibrium
Goals • Identify inflationary and recessionary gaps in long-run aggregate equilibrium. • Identify fiscal policies the government may take to combat supply shocks and demand shocks. • Explain the problems that may arise with fiscal policy in response to gaps in the economy.
I. Short-Run Macro Equilibrium “The Invisible Hand” • Applies to aggregate supply and demand as well. Demand Shock • An event that shifts the aggregate demand curve. • Causes price level and aggregate output to move in the same direction. • Use expansionary and contractionary fiscal policy. Supply Shock • An event that shifts the short-run aggregate supply curve. • Causes price level and aggregate output to move in opposite directions. • Any policy that shifts aggregate demand helps one problem, but will make the other problem worse.
II. Long-Run Macro Equilibrium Recessionary Gap • When aggregate output is below potential output. • Ex. Great Depression Inflationary Gap • When aggregate output is above potential output. • Ex. . com Boom
III. Responses to Long-Run Disequilibrium Stabilization Policies • The use of government policy to reduce the severity of recessions and rein in excessively strong expansions through taxation and government spending. • Promoted by John Maynard Keynes as a solution to the Great Depression. • Keynes, “In the long run we are all dead. ”
III. Responses to Long-Run Disequilibrium Expansionary Policy Contractionary Policy • Increase aggregate demand. • Response to a demand shock (recessionary gap) to prevent high unemployment and excessive deflation. • Characterized by an increase in government spending and a decrease in taxes. • Reduces aggregate demand. • Response to an inflationary gap to prevent excessive growth. • Characterized by a reduction in government spending and an increase in government taxes.
IV. Problems with Fiscal Policy Government has to realize there is a recession. The government has to develop a spending plan. Because of the lag in fiscal policy, sometimes the economy ends up selfcorrecting and the new fiscal policy will result in an inflationary gap. Takes time to spend the money.
V. Practice • 1) Which of the following causes a negative supply shock? i. A technological advance ii. Increasing productivity iii. An increase in oil prices a) b) c) d) e) I only III only I and III only I, II, and III
V. Practice • 2) Which of the following causes a positive demand shock? a) b) c) d) e) An increase in wealth Pessimistic consumer expectations A decrease in government spending An increase in taxes An increase in the existing stock of capital
V. Practice • 3) Which of the following contributes to the lag of implementing fiscal policy? i. It takes time for Congress and the President to pass spending and tax changes, ii. Current economic data take time to collect and analyze. iii. It takes time to realize an output gap exists. a) b) c) d) e) I only III only I and III only I, II, and III
V. Practice • 4) Which of the following is an example of expansionary fiscal policy? a) b) c) d) e) Increasing taxes Increasing government spending Decreasing government transfers Decreasing interest rates Increasing the money supply
V. Practice • 5) Which of the following is fiscal policy that is appropriate to combat inflation? a) b) c) d) e) Decreasing taxes Decreasing government spending Increasing government transfers Increasing interest rates Expansionary fiscal policy
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