12. GDP is:A) the monetary value of all goods and services

(final, intermediate, and non-market) produced in a given year.

B) total resource income less taxes, saving, and spending on exports.

C) the economic value of all economic resources used in the production of a year's output.

D) the market value of all final goods and services produced within a nation in a specific year. 13. GDP can be calculated by summing:

A) consumption, investment, government purchases, exports, and imports. B) consumption, investment, government purchases, and imports. C) investment, government purchases, consumption, and net exports. D) consumption, investment, wages, and rents.

14. Which of the following best measures a nation’s standard of living:

A) unemployment rate. B) nominal GDP.C) total consumption and government spendingD) real GDP per capita.E) inflation rate

15. The phase of the business cycle in which real GDP declines for at least 2 quarters is called:

A) the peak. B) a recovery. C) a recession. D) the trough. E) a depression

16. Net exports are negative when: A) a nation's imports exceed its exports. B) the economy's stock of capital goods is

declining. C) depreciation exceeds domestic investment. D) a nation's exports exceed its imports. E) the government increases trade barriers

The Car AnalogyThe economy is like a car…• You can drive 120mph but it is not sustainable. (Extremely

Low unemployment)• Driving 20mph is too slow. The car can easily go faster.

(High unemployment)• 70mph is sustainable. (Full employment)• Some cars have the capacity to drive faster then others.

(industrial nations vs. 3rd world nations)• If the engine (technology) or the gas mileage

(productivity) increase then the car can drive at even higher speeds. (Increase AS)

The government’s job is to brake or speed up when needed as well as promote things that will improve the engine.

(Shift the PPC outward) 5

How does the Government Stabilizes the Economy?

The Government has two different tool boxes it can use:

1. Fiscal Policy-Actions by Congress to

stabilize the economy.OR

2. Monetary Policy-Actions by the Federal

Reserve Bank to stabilize the economy.

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For now we will only focus on Fiscal Policy.

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Fiscal Policy

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Two Types of Fiscal PolicyDiscretionary Fiscal Policy-• Congress creates a new bill that is designed to change

AD through government spending or taxation.•Problem is time lags due to bureaucracy. •Takes time for Congress to act. •Ex: In a recession, Congress increase spending.

Non-Discretionary Fiscal Policy•AKA: Automatic Stabilizers•Permanent spending or taxation laws enacted to work

counter cyclically to stabilize the economy •Ex: Welfare, Unemployment, Min. Wage, etc.•When there is high unemployment, unemployment

benefits to citizens increase consumer spending.

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Laws that reduce inflation, decrease GDP (Close a Inflationary Gap)

• Decrease Government Spending• Tax Increases• Combinations of the Two

Contractionary Fiscal Policy (The BRAKE)

Laws that reduce unemployment and increase GDP (Close a Recessionary Gap)

• Increase Government Spending• Decrease Taxes on consumers• Combinations of the Two

Expansionary Fiscal Policy (The GAS)

How much should the Government Spend? 10

Non-Discretionary Fiscal Policy

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Non-Discretionary Fiscal PolicyLegislation that act counter cyclically without

explicit action by policy makers.AKA: Automatic Stabilizers

The U.S. Progressive Income Tax System acts counter cyclically to stabilize the economy.1. When GDP is down, the tax burden on

consumers is low, promoting consumption, increasing AD.

2. When GDP is up, more tax burden on consumers, discouraging consumption, decreasing AD.

The more progressive the tax system, the greater the economy’s built-in stability. 12

Problems With Fiscal Policy

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Problems With Fiscal Policy•When there is a recessionary gap what two options does Congress have to fix it?•What’s wrong with combining both?

Deficit Spending!!!!•A Budget Deficit is when the government’s expenditures exceeds its revenue. •The National Debt is the accumulation of all the budget deficits over time. •If the Government increases spending without increasing taxes they will increase the annual deficit and the national debt.

Most economists agree that budget deficits are a necessary evil because forcing a balanced budget would

not allow Congress to stimulate the economy. 14

Explain this cartoon

200315

Who ultimately pays for excessive government spending?

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Additional Problems with Fiscal Policy1. Problems of Timing

• Recognition Lag- Congress must react to economic indicators before it’s too late

• Administrative Lag- Congress takes time to pass legislation

• Operational Lag- Spending/planning takes time to organize and execute ( changing taxing is quicker)

2. Politically Motivated Policies• Politicians may use economically inappropriate

policies to get reelected. • Ex: A senator promises more welfare and public

works programs when there is already an inflationary gap.

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3. Crowding-Out Effect• In basketball, what is “Boxing Out”?• Government spending might cause unintended

effects that weaken the impact of the policy.Example:• Government creates new public library. (AD increases)• Now but consumer spend less on books (AD decreases)Another Example:• The government increases spending but must borrow

the money (AD increases) • This increases the price for money (the interest rate).• Interest rates rise so Investment to fall. (AD decrease)

The government “crowds out” consumers and/or investors

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Additional Problems with Fiscal Policy

4. Net Export EffectInternational trade reduces the effectiveness

of fiscal policies. Example:

• We have a recessionary gap so the government spends to increase AD.

• The increase in AD causes an increase in price level and interest rates.

• U.S. goods are now more expensive and the US dollar appreciates…

• Foreign countries buy less. (Exports fall)• Net Exports (Exports-Imports) falls, decreasing AD.

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Additional Problems with Fiscal Policy

Explain this cartoon

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Congressional CommitteesAs a group, analyze the situation, identify the

problem, and identify your solution

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Unemployment Inflation GDP Growth

Good 6% or less 1%-4% 2.5%-5%

Worry 6.5%-8% 5%-8% 1%-2%

Bad 8.5 % or more 9% or more .5% or less

The Good, the Bad, and the Ugly

1.) 1933Situation:• GDP fell -1.2%• Inflation rate= -.5%• Unemployment Rate=25%Your Solution:What actually happened:• FDR increased public works via the New Deal

programs.

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2.) 1944Situation:• GDP grew 8%• Inflation rate= 3.7%• Unemployment Rate=1.2%Your Solution: What actually happened: • War ended the next year and government

orders for war materials decreased.• Many public works programs were

discontinued26

3.) 1980Situation:• GDP fell -0.3%• Inflation rate= 13.5%• Unemployment Rate=7.1%Your Solution: What actually happened:• The next year, President Regan and congress

lowered taxes on individuals and corporations by about 30%. (Supply-side Economics)

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4.) 2003Situation:• GDP fell 0.5%• Inflation rate= 1.5%• Unemployment Rate=12.0%Your Solution:What actually happened:• Congress voted to give tax cuts to citizens.

(Bush Tax Cuts)

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