Review Notes - Government Fiscal Policy

- add G to the model?

- AE_a = C_a + I_a + G_a

- all else the same as above

- Hence, addition of G is the same as any other increase in AE_a

- equilibrium Y = m*AE_a

- add taxes (T) to the model?

- let taxes be autonomous (i.e., not depend on Y)

- T = T_a

- Y_d = Y - T_a

- Y = C + S + T

- C = C_a + mpc (Y - T_a)

- S = -C_a + mps (Y - T_a)

- what happens to AE curve graphically?

- what is equilibrium now?

- Y = AE

- I + G (injections) = S + T (leakages)

- unplanned I = 0

- equilibrium Y = (AE_a - mpc*T_a)/mps (why?)

- the tax multiplier (m_t)

- m_t = D Y/D T = - mpc/mps

- interpretation of the tax multiplier?

- balanced budget multiplier (m_bb)

- suppose D G = D T, by how much does eq. Y change?

- m_bb = 1 (why? = m + m_t)

- equilibrium Y = m*AE_a + m_t*T_a

- Keynesian Fiscal Policy

- fiscal policy = changes in G, T or both

- expansionary fiscal policy

- increase G, decrease T, both, or balanced budget increase in G

- recessionary fiscal policy

- decrease G, increase T, both, or balanced budget decrease in G

- the government budget is in deficit if G > T at equilibrium Y

- the government budget is in surplus if G < T at equilibrium Y

- Non-discretionary Fiscal Policy

- changes in government spending or taxes that are automatic.

- can you think of any examples and how they work?

- The Full Employment Budget

- when is the government's policy recessionary/expansionary?

- if the budget is in deficit at Y_f then it's expansionary.

- if the budget is in surplus at Y_f then it's recessionary.

- why?