Lecture Issues in economics today - Chapter 11

When you finish this chapter, you should: Define the key terms of economics and opportunity cost and understand how a production possibilities frontier exemplifies the trade-offs that exist in life, distinguish between increasing and constant opportunity cost and understand why each might happen in the real world, analyze an argument by thinking economically, while recognizing and avoiding logical traps.
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Lecture Issues in economics today - Chapter 11 Chapter 11 Fiscal Policy McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Chapter Outline • NONDISCRETIONARY AND DISCRETIONARY FISCAL POLICY • USING FISCAL POLICY TO COUNTERACT “SHOCKS” • EVALUATING FISCAL POLICY McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Fiscal Policy • Fiscal Policy is the purposeful movement in government spending or tax policy designed to direct an economy • Discretionary Fiscal Policy: government spending and tax changes enacted at the time of the problem to alter the economy • Nondiscretionary Fiscal Policy: that set of policies that are built into the system to stabilize the economy McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. How Nondiscretionary Fiscal Policy Works • Nondiscretionary fiscal policy consists of policies that are built into the system so that an expansionary or contractionary stimulus can be given automatically. • The welfare state and the progressive income tax serve as the built-in policies. – If the economy is in recession, those who lose their jobs are granted unemployment and welfare benefits and they owe less in taxes. – If the economy is growing at an unsustainable rate, people are making a lot of money and are faced with higher tax rates and there are fewer people eligible for government benefits. McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. How Discretionary Fiscal Policy Works • If we are in a recession the fiscal policy to stimulate the economy would consist of – Increases in government spending – Decreases in taxes • If we are in an inflationary period the fiscal policy to contract the economy would consist of – Decreases in government spending – Increases in taxes McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Expansionary Fiscal Policy PI AS PI’ PI* AD’ AD RGDP* RGDP’ RGDP McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Contractionary Fiscal Policy PI AS PI* PI’ AD AD’ RGDP’ RGDP* RGDP McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Shocks • A Shock is any unanticipated economic event. – Aggregate Demand Shock: an unexpected event which causes aggregate demand to increase or decrease, e.g. the Sept 11, 2001 terrorist attacks. – Aggregate Supply Shock: an unexpected event which causes aggregate supply to increase or decrease, e.g. Iraq’s 1990 invasion of Kuwait and threat to Saudi Arabia. McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Nondiscretionary and Discretionary Fiscal Policy Combats a Recession PI AS Shock NDFP PI* AD3 AD1 DFP AD2 RGDP* RGDP McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved.Nondiscretionary and Discretionary FiscalPolicy Combats an Overheated Economy PI AS Shock NDFP AD2 PI* DFP AD3 AD1 RGDP* RGDP McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRi ...