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Demand-Side Policy: Demand-Side Policy: Greater Spending Greater Spending Means Higher PricesMeans Higher Prices
Real GDP
Pri
ce
Le
ve
l
(c) Aggregate Demand and Supply in the classical range of AS curve. (Prices rise without significant improvements in output and employment.)
AD1
AD
Y?
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Analysis of a Analysis of a Tax-and-Spend Tax-and-Spend PolicyPolicy
Government increases spending, but finances it with tax increases. The increase in spending shifts AD to the right, but the increase in taxes reduces the incentive to work(???), shifting AS to the left.
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Crowding OutCrowding Out
Government Deficit Borrowing by Government
Government Demand for Credit Interest Rates UP.
Higher interest rates Investment Spending DOWN
Private investment is “crowded out” by debt-financed public (gov’t) spending.
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Other impacts of Other impacts of Budget Deficits and National DebtBudget Deficits and National Debt
Crowding out of private investment Future capital stock DOWN Future Output DOWN .
Interest rates UP Currency Appreciation Foreign Goods Cheaper Imports UP Net Exports DOWN GDP DOWN
National Debt UP Interest paid by government UP.
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U.S. Government U.S. Government Revenues and Revenues and ExpendituresExpenditures
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U.S. Government Expenditures U.S. Government Expenditures as a Percentage of GDPas a Percentage of GDP
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Fiscal Policy: Some Definitions
Demand-side policies: spending and tax policies designed to stimulate or slow aggregate demand.
Supply-side policies: policies designed to increase productivity and enterprise.
Discretionary Fiscal Policy: changes in government spending and/or taxation aimed at achieving a policy goal.
Automatic Stabilizer: an element of fiscal policy that changes automatically as income changes.
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Automatic StabilizersAutomatic Stabilizers
Progressive Taxes– As income falls, the tax rate also falls,
helping to maintain buying power and hence aggregate demand
Transfer Payments – Examples: Unemployment insurance,
welfare, subsidies– Insure that buying power is not reduced at
the same rate as income
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Taxes: Some Definitions
Direct taxes: on individuals and firms. Examples: income taxes and value-added
taxes (VAT). Indirect taxes: on goods and servicesTax rate structures:
– progressive tax: rate increases with higher income.
– regressive tax: rate falls with higher income.– proportional tax: rate is constant.
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Central Government Spending by Central Government Spending by Functional CategoryFunctional Category
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Supply-Side Economics and the Laffer Curve
•Taxes are a disincentive to productive activity.
•At marginal tax rates greater than t, the tax base shrinks at a faster rate than the increases in marginal tax rate.
•Net result: increases in marginal tax rates beyond t result in reduced tax revenues.
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