Principles Of Economics Chapter 24 PDF

Principles of Economics Twelfth Edition Chapter 24 The Government and Fiscal Policy Copyright©©2017 Copyright 2017Pearson...

Principles of Economics Twelfth Edition Chapter 24 The Government and Fiscal Policy Copyright©©2017 Copyright 2017Pearson PearsonEducation, Education,Inc. Inc. 24-1 Copyright Copyright © 2017 Pearson Education, Inc. 24-2 Chapter Outline and Learning Objectives (1 of 2) 24.1 Government in the Economy Discuss the influence of fiscal policies on the economy. 24.2 Fiscal Policy at Work: Multiplier Effects Describe the effects of three fiscal policy multipliers. 24.3 The Federal Budget Compare and contrast the federal budgets of three U.S. government administrations. Copyright©©2017 Copyright 2017Pearson PearsonEducation, Education,Inc. Inc. 24-3 Chapter Outline and Learning Objectives (2 of 2) 24.4 The Economy’s Influence on the Government Budget Explain the influence of the economy on the federal government budget. Looking Ahead Appendix A: Deriving the Fiscal Policy Multipliers Show that the government spending multiplier is 1 divided by 1 minus the MPC. Appendix B: The Case in Which Tax Revenues Depend on Income Explain why the multiplier falls when taxes depend on income. Copyright©©2017 Copyright 2017Pearson PearsonEducation, Education,Inc. Inc. 24-4 Chapter 24 The Government and Fiscal Policy In macroeconomics, the policy instruments are fiscal policy and monetary policy. fiscal policy The government’s spending and taxing policies. monetary policy The behavior of the central bank concerning the nation’s money supply. Copyright © 2017 Pearson Education, Inc. 24-5 Government in the Economy Taxes and government spending often go up or down in response to changes in the economy. discretionary fiscal policy Changes in taxes or spending that are the result of deliberate changes in government policy. Copyright © 2017 Pearson Education, Inc. 24-6 Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) (1 of 5) 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. Copyright © 2017 Pearson Education, Inc. 24-7 FIGURE 24.1 Adding Net Taxes (T) and Government Purchases (G) to the Circular Flow of Income Copyright © 2017 Pearson Education, Inc. 24-8 Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) (2 of 5) Copyright © 2017 Pearson Education, Inc. 24-9 Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) (3 of 5) budget deficit The difference between what a government spends and what it collects in taxes in a given period: G − T. Copyright © 2017 Pearson Education, Inc. 24-10 Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) (4 of 5) Adding Taxes to the Consumption Function To modify our aggregate consumption function to incorporate disposable income: The consumption function now has consumption depending on disposable income instead of before-tax income. Copyright © 2017 Pearson Education, Inc. 24-11 Government Purchases (G), Net Taxes (T), and Disposable Income (Yd) (5 of 5) Planned Investment The government can affect investment behavior through its tax treatment of depreciation and other tax policies. Planned investment depends on the interest rate. Copyright © 2017 Pearson Education, Inc. 24-12 The Determination of Equilibrium Output (Income) (1 of 2) Copyright © 2017 Pearson Education, Inc. 24-13  TABLE 24.1 Finding Equilibrium for I = 100, G = 100, and T = 100 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) Output Net Disposabl Consump Saving Planned Govern Planned Unplanned Adjustment (Income) Taxes e tion S Investmen ment Aggregat Inventory to Dis- Y T Income Spending Yd – C t Purchas e Change equilibrium Yd ≡Y −T C = 100 Spending es Expendit Y − (C + I + +.75 Yd I G ure G) C+I+G 300 100 200 250 −50 100 100 450 −150 Output 500 100 400 400 0 100 100 600 −100 Output 700 100 600 550 50 100 100 750 −50 Output 900 100 800 700 100 100 100 900 0 Equilibrium 1,100 100 1,000 850 150 100 100 1,050 +50 Output 1,300 100 1,200 1,000 200 100 100 1,200 +100 Output 1,500 100 1,400 1,150 250 100 100 1,350 +150 Output Copyright © 2017 Pearson Education, Inc. 24-14 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. Copyright © 2017 Pearson Education, Inc. 24-15 The Determination of Equilibrium Output (Income) (2 of 2) The Saving/Investment Approach to Equilibrium Copyright © 2017 Pearson Education, Inc. 24-16 Fiscal Policy at Work: Multiplier Effects At this point, we are assuming that the government controls G and T. We now review three multipliers: – Government spending multiplier – Tax multiplier – Balanced-budget multiplier Copyright © 2017 Pearson Education, Inc. 24-17 The Government Spending Multiplier government spending multiplier The ratio of the change in the equilibrium level of output to a change in government spending. Copyright © 2017 Pearson Education, Inc. 24-18  TABLE 24.2 Finding Equilibrium after a Government Spending Increase of 50* (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) Output Net Disposabl Consump Saving Planned Govern Planned Unplanned Adjustment (Income) Taxes e tion S Investmen ment Aggregat Inventory to Dis- Y T Income Spending Yd – C t Purchas e Change equilibrium Yd ≡Y −T C = 100 Spending es Expendit Y − (C + I + +.75 Yd I G ure G) C+I+G 300 100 200 250 −50 100 150 500 −200 Output 500 100 400 400 0 100 150 650 −150 Output 700 100 600 550 50 100 150 800 −100 Output 900 100 800 700 100 100 150 950 −50 Output 1,100 100 1,000 850 150 100 150 1,100 0 Equilibrium 1,300 100 1,200 1,000 200 100 150 1,250 50 Output * G has increased from 100 in Table 24.1 to 150 here. Copyright © 2017 Pearson Education, Inc. 24-19 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. Copyright © 2017 Pearson Education, Inc. 24-20 TABLE 24.3 Finding Equilibrium after a Balanced-Budget Increase in G and T of 200 Each* (1) (2) (3) (4) (5) (6) (7) (8) (9) Output Net Disposable Consumpti Planned Governm Planned Unplanned Adjustment (Income) Taxes Income on Investment ent Aggregate Inventory to Dis- Y T Yd ≡Y −T Spending Spending Purchase Expenditur Change equilibrium C = 100 I s e Y − (C + I + +.75 Yd G C+I+G G) 500 300 200 250 100 300 650 −150 Output 700 300 400 400 100 300 800 −100 Output 900 300 600 550 100 300 950 -50 Output 1,100 300 800 700 100 300 1,100 0 Equilibrium 1,300 300 1,000 850 100 300 1,250 +50 Output 1,500 300 1,200 1,000 100 300 1,400 +100 Output * Both G and T have increased from 100 in Table 24.1 to 300 here. Copyright © 2017 Pearson Education, Inc. 24-21 Fiscal Policy since 1993: The Clinton, Bush, and Obama Administrations FIGURE 24.4 Federal Personal Income Taxes as a Percentage of Taxable Income, 1993 I–2014 IV MyEconLab Real-time data Copyright © 2017 Pearson Education, Inc. 24-22 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–2014 IV MyEconLab Real-time data Copyright © 2017 Pearson Education, Inc. 24-23 FIGURE 24.6 The Federal Government Surplus (+) or Deficit (−) as a Percentage of GDP, 1993 I–2014 IV MyEconLab Real-time data Copyright © 2017 Pearson Education, Inc. 24-24 ECONOMICS IN PRACTICE Long-Term Projections of the Federal Government Budget In 2014, the Congressional Budget Office (CBO) estimated that the federal debt was 74% of GDP but would decrease in the next few years as the economy continued to recover. In the long term, however, the CBO estimated that the debt would increase substantially, to more than 100% of GDP by 2039, largely because of the costs associated with the aging of the U.S. population. THINKING PRACTICALLY 1. Why does the aging of the population increase the debt? Copyright © 2017 Pearson Education, Inc. 24-25 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. Copyright © 2017 Pearson Education, Inc. 24-26 FIGURE 24.7 The Federal Government Debt as a Percentage of GDP, 1993 I–2014 IV MyEconLab Real-time data Copyright © 2017 Pearson Education, Inc. 24-27 The Economy’s Influence on the Government Budget (1 of 2) Automatic Stabilizers and Destabilizers 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. automatic destabilizers Revenue and expenditure items in the federal budget that automatically change with the state of the economy in such a way as to destabilize GDP. 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. Copyright © 2017 Pearson Education, Inc. 24-28 The Economy’s Influence on the Government Budget (2 of 2) 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. Copyright © 2017 Pearson Education, Inc. 24-29 REVIEW TERMS AND CONCEPTS (1 of 2) automatic destabilizers fiscal drag automatic stabilizers fiscal policy balanced-budget multiplier full-employment budget budget deficit government spending multiplier cyclical deficit monetary policy discretionary fiscal policy net taxes (T) disposable, or after-tax, income (Yd) privately held federal debt federal budget structural deficit federal debt tax multiplier federal surplus (+) or deficit (−) Copyright © 2017 Pearson Education, Inc. 24-30 REVIEW TERMS AND CONCEPTS (2 of 2) Equations: Copyright © 2017 Pearson Education, Inc. 24-31 CHAPTER 24 APPENDIX A: Deriving the Fiscal Policy Multipliers The Government Spending and Tax Multiplier Copyright © 2017 Pearson Education, Inc. 24-32