Principles of macroeconomics 10e by case fair oster ch09

Government in the EconomyGovernment Purchases G, Net Taxes T, and Disposable Income Y d The Determination of Equilibrium Output Income Fiscal Policy at Work: Multiplier Effects The Gover

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Government in the Economy

Government Purchases (G), Net Taxes (T), and Disposable Income (Y d)

The Determination of Equilibrium Output (Income)

Fiscal Policy at Work: Multiplier Effects

The Government Spending Multiplier The Tax Multiplier

The Balanced-Budget Multiplier

The Federal Budget

The Budget in 2009 Fiscal Policy Since 1993: The Clinton, Bush, and Obama Administrations

The Federal Government Debt

The Economy’s Influence on the Government Budget

Automatic Stabilizers and Destabilizers Full-Employment Budget

Looking Ahead Appendix A: Deriving the Fiscal Policy Multipliers

Appendix B: The Case in Which Tax Revenues Depend on Income

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fiscal policy The government’s spending and taxing policies

monetary policy The behavior of the Federal Reserve concerning the nation’s money supply

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a Discretionary fiscal policy.

b Automatic fiscal policy

c Budgetary policy

d Monetary policy

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The behavior of the Federal Reserve concerning the nation’s money supply is called:

a Discretionary fiscal policy

b Automatic fiscal policy

c Budgetary policy

d Monetary policy.

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Government in the Economy

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Over which of the following categories does the government have more control?

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 FIGURE 9.1 Adding Net Taxes (T)

and Government Purchases (G) to

the Circular Flow of Income

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The disposable income (Y d) of households must end up as either

consumption (C) or saving (S) Thus,

Y d  C  S

Y  C  S  T

Because disposable income is aggregate income (Y) minus net taxes (T), we can write another identity:

By adding T to both sides:

Planned aggregate expenditure (AE) is the sum of consumption spending by households (C), planned investment by business firms (I), and government purchases of goods and services (G).

G I

C

AE   

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Select the best answer Households use their disposable income

(Y d) to do the following:

a Consume

b Consume and save

c Consume, save, and pay taxes

d Consume, save, pay taxes, and buy imports

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b Consume and save.

c Consume, save, and pay taxes

d Consume, save, pay taxes, and buy imports

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budget deficit The difference between what a government spends

and what it collects in taxes in a given period: G − T

budget deficit ≡ G − T

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Our consumption function now has consumption depending

on disposable income instead of before-tax income

Adding Taxes to the Consumption Function

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When government enters the circular flow of income, which of the following is an expression for planned aggregate expenditure?

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The government can affect investment behavior through its tax treatment of depreciation and other tax policies

Planned Investment

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Disposable Income

Y d ≡Y  T

Consumption Spending

I

Government Purchases

G

Planned Aggregate Expenditure

C + I + G

Unplanned Inventory Change

Y  (C + I + G)

Adjustment

to librium

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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.

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To derive this, we know that in equilibrium, aggregate

output (income) (Y) equals planned aggregate expenditure (AE) By definition, AE equals C + I + G, and by definition,

Y equals C + S + T.

Therefore, at equilibrium:

C + S + T = C + I + G Subtracting C from both sides leaves:

S + T = I + G

The Saving/Investment Approach to Equilibrium

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In the circular flow that includes households, firms, and government, which of the following expressions is the leakages/injections approach to equilibrium?

c Y = a + bT + I + G

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c Y = a + bT + I + G.

d. S + T = I + G.

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At this point, we are assuming that the government controls G and T In this

section, we will review three multipliers:

Government spending multiplierTax multiplier

Balanced-budget multiplier

Fiscal Policy at Work: Multiplier Effects

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

government spending multiplier The ratio of the change in the equilibrium level of output to a change in government spending

The Government Spending Multiplier

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TABLE 9.2 Finding Equilibrium after a Government Spending Increase of 50 (G Has

Increased from 100 in Table 9.1 to 150 Here)

T

Y d ≡Y  T

I

G

C + I + G

Y  (C + I + G)

Adjustment to Disequilibrium

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How much of an increase in government spending would be required

to generate a $200 billion increase in the equilibrium level of output?

a An amount less than $200 billion in government spending

b An amount greater than $200 billion in government spending

c Exactly $200 billion in government spending

d None of the above Equilibrium output does not change with changes in government spending

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How much of an increase in government spending would be required

to generate a $200 billion increase in the equilibrium level of output?

a An amount less than $200 billion in government spending.

b An amount greater than $200 billion in government spending

c Exactly $200 billion in government spending

d None of the above Equilibrium output does not change with changes in government spending

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 FIGURE 9.3 The Government

Spending MultiplierIncreasing 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.

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tax multiplier The ratio of change in the equilibrium level of output to

The Tax Multiplier

Because the initial change in aggregate expenditure caused by a tax

change of ∆T is (−∆T × MPC), we can solve for the tax multiplier by

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Which of the following formulas shows the impact of a change in taxes on equilibrium income?

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TABLE 9.3 Finding Equilibrium after a Balanced-Budget Increase in G and T of 200 Each

(Both G and T Have Increased from 100 in Table 9.1 to 300 Here)

T

Y d ≡Y  T

C = 100 + 75 Y d

Planned Investment Spending

I

G

C + I + G

Y  (C + I + G)

Adjustment to Disequilibrium

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c.Equilibrium income would decrease by $200, or double the

amount of the increase in T

d.Nothing happens Equilibrium income remains the same

because the amount of government spending (G) is compensated

by the amount of taxation (T).

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What happens when there is a simultaneous increase in government spending of $100 and a lump-sum tax of $100?

a Equilibrium income would increase by $100, or the amount of increase in G.

b Equilibrium income would decrease by $100, or the

amount of increase in T.

c.Equilibrium income would decrease by $200, or double the

amount of the increase in T

d.Nothing happens Equilibrium income remains the same

because the amount of government spending (G) is compensated

by the amount of taxation (T).

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TABLE 9.4 Summary of Fiscal Policy Multipliers

Policy Stimulus Multiplier Final Impact onEquilibrium Y

Tax multiplier Increase or decrease in the

level of net taxes: ∆T

Balanced-budget

multiplier

Simultaneous balanced-budget increase or decrease in the level of government purchases

and net taxes: ∆G = ∆T

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A Warning

Although we have added government, the story told about the multiplier is still incomplete and oversimplified

We have been treating net taxes (T) as a lump-sum, fixed

amount, whereas in practice, taxes depend on income

Appendix B to this chapter shows that the size of the multiplier is reduced when we make the more realistic assumption that taxes depend on income

We continue to add more realism and difficulty to our analysis

in the chapters that follow

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federal budget The budget of the federal government

The “budget” is really three different budgets:

It is a political document that dispenses favors to certain groups or regions and

places burdens on others

It is a reflection of goals the government wants to achieve.

The budget may be an embodiment of some beliefs about how (if at all) the

government should manage the macroeconomy

The Federal Budget

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The federal budget can be conceived as:

a A political document that dispenses favors to some groups

and places burdens on others

b A reflection of goals the government wants to achieve

c An embodiment of some beliefs about how (if at all) the

government should manage the macroeconomy

d All of the above

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The federal budget can be conceived as:

a A political document that dispenses favors to some groups

and places burdens on others

b A reflection of goals the government wants to achieve

c An embodiment of some beliefs about how (if at all) the

government should manage the macroeconomy

d All of the above.

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TABLE 9.5 Federal Government Receipts and Expenditures, 2009 (Billions of Dollars)

Amount Percentage of Total

Current receipts

Current transfer receipts from business and persons 68.1 3.1 Current surplus of government enterprises − 4.9 − 0.2

Current Expenditures

Transfer payments to the rest of the world 61.7 1.8 Grants-in-aid to state and local governments 476.6 13.8

Net federal government saving—surplus (+) or deficit (−)

(Total current receipts − Total current expenditures) − 1,226.4

The Federal Budget

The Budget in 2009

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 FIGURE 9.4 Federal Personal Income Taxes as a Percentage of Taxable Income, 1993 I–2010 I

The Federal Budget

Fiscal Policy Since 1993: The Clinton, Bush, and Obama Administrations

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The Federal Budget

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 FIGURE 9.6 The Federal Government Surplus (+) or Deficit (–) as a Percentage of GDP, 1993 I–2010 I

The Federal Budget

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After a large deficit buildup in the 1980s, the federal government deficit:

a Continued to worsen steadily throughout the 1990s and into the 2000s

b Turned into a surplus during the two Clinton administrations

c Was vastly diminished during the G.W Bush administrations

d Was virtually eliminated by the Obama administration

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After a large deficit buildup in the 1980s, the federal government deficit:

a Continued to worsen steadily throughout the 1990s and into the 2000s

b Turned into a surplus during the two Clinton administrations.

c Was vastly diminished during the G.W Bush administrations

d Was virtually eliminated by the Obama administration

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federal debt The total amount owed by the federal government.

privately held federal debt The privately held owned) debt of the U.S government

(non-government-The Federal Budget

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 FIGURE 9.7 The Federal Government Debt as a Percentage of GDP, 1993 I–2010 1

The Federal Budget

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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

The Economy’s Influence on the Government Budget

Automatic Stabilizers and Destabilizers

automatic destabilizer 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

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Which of the following statements is correct about the government’s control over its budget?

a The government has complete control over the revenue side

of the budget, but not complete control over the expenditure side

b The government has complete control over the expenditure side of the budget, but not complete control over the revenue side

c The government does not have complete control of either the revenue side or the expenditure side of the budget

d The size of the government budget, and whether it is in surplus or deficit, is controlled entirely by Congress, not by the economy

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a The government has complete control over the revenue side

of the budget, but not complete control over the expenditure side

b The government has complete control over the expenditure side of the budget, but not complete control over the revenue side

c The government does not have complete control of either the revenue side or the expenditure side of the budget.

d The size of the government budget, and whether it is in surplus or deficit, is controlled entirely by Congress, not by the economy

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Governments Disagree on How Much More Spending Is Needed

The U.S economy is intertwined with the rest

of the world

For that reason, U.S government leaders are

concerned not only with their own fiscal

policies but also with those of other

governments (and vice versa)

President Obama was among the strongest

advocates of additional stimulus by

governments in a June 2010 summit of the

G-20

Spending Fight at G-20

The Wall Street Journal

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