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Chapter Twenty FiveChapter Twenty Five
The Government and The Government and Fiscal PolicyFiscal Policy
Government in the EconomyGovernment in the Economy
Fiscal Authority: Congress and the President and state and local officialsResponsibilities:
–Set purchasing levels (G)
–Set taxes (T)We’ll assume that G and T are set at constant levels.
Disposable IncomeDisposable Income
Net Taxes: taxes minus transfersDisposable income: income minus taxes
Yd = Y - T
Aggregate ExpendituresAggregate Expenditures- with Government -- with Government -
AE = C + I + GAE = C + I + G
Yd = Y - T
Yd = C + S
Y - T = C + S
Y = C + S + T
The Model EconomyThe Model Economy
C = 500 + 0.75*(Income - Taxes)
= 500 + 0.75*Yd
I = 50 G = 100 and T = 60.
EquilibriumEquilibriumC + I + G = AE
– 500 + 0.75*Incomed + 50 + 100 = AE
– 650 + 0.75*Incomed = AE
AE = Income
–650 + 0.75*Incomed = Income
–650 + 0.75*(Income - 60) = Income–605= (1 - 0.75)*Income–2420 = Income2420 = Income
EquilibriumEquilibrium
Income = 2420– C = 500 + 0.75*(2420 - 60) = 2270– S = 2420 - Taxes - C = 90
C + I + G = 2270 + 50 + 150 = 2420 = Y S + Taxes = 150 = 100 + 50 = G + I
EquilibriumEquilibrium
Income = 2420– C = 500 + 0.75*(2420 - 60) = 2270– S = 2420 - Taxes - C = 90
C + I + G = 2270 + 50 + 150 = 2420 = Y S + Taxes = 150 = 100 + 50 = G + I
Note that S + T = G + I
Consumption=500+.75Yd
Aggregate PlannedExpenditures
Income
Savings + Taxes
500
550
Investment=$50
C
C+I
C+I+G
Government=100
650
45o
Income
500
C
C+I+G = AE
650
Y=2240
GDP
Aggregate PlannedExpenditures
45o
Income
500
550
C
C+I
C+I+G
650Consumption
Savings + Taxes
2240
Aggregate PlannedExpenditures
45o
Income
500
550
C
C+I
C+I+G
650Consumption
G + I
2240
Aggregate PlannedExpenditures
45o
AE = C + I + G
Income (Y)2950
2950
C = 500 + 0.8*YG=50, T=0
I=40
Expenditures
45o
C + I + G1
Income (Y)2950
2950
C = 500 + 0.8*YG=60, T=0
I=40
Expenditures
Suppose G increases by 10, taxes increase by 0.
3000
3000
C + I + G2
Y increases by 50
45o
The Government Spending The Government Spending MultiplierMultiplier
G = 10 and Y = 50Multiplier = 50/10 = 5Multiplier = 1/(1-MPC) = 5
AE2 = C + I + G
Income (Y)2950
2950 C = 500 + 0.8*YG=50, T=10
I=40
Expenditures
Suppose T increases by 10
2910
2910
AE1 = C + I + G
Y decreases by 40
The Tax MultiplierThe Tax Multiplier
T = 10 and Y = -40Multiplier = -40/10 = -4Multiplier = MPC/(1-MPC) = -4
AE2 = C + I + G
Income (Y)2950
2950
C = 500 + 0.8*YG=60, T=10
I=40
Expenditures
Suppose G increases by 10, T increases by 10
2960
2960
AE1 = C + I + G
Y increasesincreases by 1045o
Balanced Budget MultiplierBalanced Budget Multiplier
G = 10 and Y = 10Multiplier = 10/10 = 1 1
MultipliersMultipliers
= = 1
1-MPC
1
1-MPC
1
1-MPC
Governmentspendingmultiplier
Governmentspendingmultiplier
Investmentspendingmultiplier
Investmentspendingmultiplier
Consumptionspendingmultiplier
Consumptionspendingmultiplier
= =
MultipliersMultipliers
1>MPC
1-MPC> 1
1-MPC
Governmentspendingmultiplier
Governmentspendingmultiplier
Taxdecrease
multiplier
Taxdecrease
multiplier
Balancedbudget
multiplier
Balancedbudget
multiplier>>
The Federal Budget, Deficit, The Federal Budget, Deficit, and Debtand Debt
DeficitDeficit = G - Taxes
–cyclical deficitcyclical deficit: part of deficit which is due to the business cycle
–structural deficitstructural deficit: part of deficit which exists even at full employment
Receipts and OutlaysReceipts and Outlays
Federal Receipts and Outlays, 1939-1994 (Billions of Current Dollars)
0200400600800
1000120014001600
1939 1947 1955 1963 1971 1979 1987 1994
Years
Bil
lion
s of
Dol
lars
Source: "Economic Report of the President, 1995", Table B-74, p. 435.
Receipts
Outlays
Federal DeficitFederal Deficit
Federal Surplus or Deficit, 1939-1994 (Billions of Current Dollars)
-300
-250
-200
-150
-100
-50
0
50
1939 1943 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991
Years
Bil
lion
s of
Dol
lars
Source: "Economic Report of the President, 1995", Table B-74, p. 435.
1994
Measuring the DeficitMeasuring the Deficit
Deficit = Expenditures - TaxesAs a percentage of GDP
Deficit as a Percentage of GDPDeficit as a Percentage of GDP
-35
-30
-25
-20
-15
-10
-5
0
5
1934
1938
1942
1946
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
National DebtNational Debt
The national debtnational debt refers to the total accumulation of past deficits.
The Economy’s Influence on The Economy’s Influence on the Deficitthe Deficit
Fiscal dragTax revenues that depend on the economyExpenditures that depend on the economyAutomatic stabilizers
Government Deficits and Debt as a Government Deficits and Debt as a Percentage of nominal GDP, 1997, for Percentage of nominal GDP, 1997, for
selected countriesselected countries
Deficit Debt
Canada 0.2 66.5
France 3.2 48.6
Germany 3.1 53.4
Italy 3.2 116.3
Japan 2.7 18.2
United Kingdom 2.0 47.9
United States 0.3 51.7
Review Terms & ConceptsReview Terms & Concepts
Automatic stabilizers Balanced budget
multiplier Budget deficit Cyclical deficit Discretionary fiscal
policy Disposable (after-tax)
income
Federal budget Federal debt Federal deficit Fiscal drag Fiscal policy Full-employment
budget Government spending
multiplier
Review Terms & Concepts Review Terms & Concepts (cont.)(cont.)
Monetary policy Net exports Net taxes Privately held federal
debt Structural deficit Tax multiplier
