Key Terms

aggregate demand aggregate supply (SRAS) automatic stabilizer balanced budget multiplier contractionary fiscal policy discretionary policy economic growth expansionary fiscal policy expenditure multiplier fiscal policy income effect interest-rate effect labor productivity leakage long run long-run aggregate marginal propensity to consume marginal propensity to save multiplier effect net export effect short run stagflation tax multiplier

Aggregate Demand is a change () in spending.

C-- Consumer spending wealth personal taxes expectations=, indebtedness Ig Investment spending interest rates business confidence profit expectations business taxes degree of excess capacity technology G Government spending purchases (X-M)-- Net Export spending national income abroad exchange rates

Aggregate Supply is a change () in per unit costs

R -- Resource prices A -- Actions by the government business taxes business subsidies business regulations P -- Productivity or technology NOTE: A leftward shift of AS increases inflation and unemployment causing stagflation

Correctly Labeled AD/AS graph

Correctly Labeled AD/AS graph showing inflation (Operating above full employment level)

Correctly Labeled AD/AS graph showing recession (Operating above below employment level)

Economic Growth Caused by a change in productivity, resources, or capital investment. (If the growth is caused by interest rate changes, then capital investment must be the reason for the change.)

Correct ways to show increased Economic Growth A decrease in Economic Growth would shift each to the left

Expenditure Multiplier If you increase G or Ig by 100, GDP will rise by more than 100 (multiplier is 1/MPS or 1/(1-MPC) ). If MPC=.8 and the government spends an extra $100 by paying Mrs. Miller a bonus for high AP pass rates, she will spend $80 taking her husband out to dinner so he will forgive her for being a workaholic, then the owner of the fancy restaurant will spend $60 of the $80 on new clothes, etc. . . Limitations: inflation and taxes erode the multiplier. So do rising interest rates. The impact on the economy would be 1/(1-.8) * 100 = 1/.2 * 100 = 5 * 100 = $500 change in the economy from a $100 increase in government spending. GDP = Expenditure Multiplier times in Spending Tax Multiplier Tax multiplier = MPC/MPS or MPC/(1-MPC). If the government cuts personal income taxes by 100 and MPC=.8, then (.8/.2) * 100 = 4 * 100 = $400 change in the economy from a $100 decrease in personal taxes. GDP = Tax Multiplier times in Personal Income Taxes G has a larger impact than T because not all of the tax savings will be spent on consumption; some of it will be saved. MPC + MPS = 1 You can spend your money or save it so this is always true. Fiscal Policy Congress stabilizing the economy through taxation and spending (budgeting) policies; Limitations include that Congress only determines the budget annually, expansionary policy causes deficits and contractionary is unpopular. Discretionary a change to address a specific economic situation Automatic built in policies like unemployment compensation, progressive income tax, etc...

Fiscal Policy Tool

Cause & Effect Chain

Increase government spending on programs.

Cause & Effect Chain

Decrease or cut government spending on programs. A decrease in government spending directly shifts AD to the left, decreasing output and price level. The decrease in output will decrease employment. Increase (raise) personal income taxes leads to less disposable income for consumers. Consumption decreases which leads to decreased aggregate demand. A decrease in AD will decrease output and price level. The decrease in output will decrease employment.

Government Expenditures

An increase in government spending directly shifts AD to the right, increasing output and price level. The increase in output will increase employment. Decrease (cut) personal income taxes leads to more disposable income for consumers. Consumption increases which leads to increased aggregate demand. An increase in AD will increase output and price level. The increase in output will increase employment.

Personal Income Taxes