Unit 5: Aggregate Demand and Supply and Fiscal Policy 1 Copyright ACDC Leadership 2015.

Unit 5:Aggregate Demand and Supply and Fiscal Policy

1Copyright ACDC Leadership 2015

1. Identify the two types of tool boxes the government has to fix the economy

2. Explain and give examples of Expansionary Fiscal Policy

3. Explain and give examples of Contractionary Fiscal Policy

4. Explain the Multiplier Effect5. Explain how to calculate the spending

multiplier6. Name 10 University Mascots

Review

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Pri

ce le

vel

Real GDP (billions)

Draw and Practice

AD1 AD

P2

$50FE $100

AS

1. What type of gap?2. Contractionary or

Expansionary needed?3. What are two options

to fix the gap?4. How much needed to

close gap?

LRAS

Congress uses discretionary fiscal policy to the manipulate the following economy (MPC = .9)

-$5 Billion

3Copyright ACDC Leadership 2015

Pri

ce le

vel

Real GDP (billions)

Draw and Practice

1. What type of gap?2. Contractionary or

Expansionary needed?3. What are two options

to fix the gap?4. How much initial

government spending is needed to close gap?

AD2 AD1 +$40 Billion

Congress uses discretionary fiscal policy to the manipulate the following economy (MPC = .8)

P1

$800 $1000FE

ASLRAS

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Problems With Fiscal Policy

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5 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?

1. 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. 6Copyright

ACDC Leadership 2015

US National Debt

7

US Debt ClockCopyright ACDC Leadership 2015

The Onion:Government Stages Coup

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5 Problems with Fiscal Policy2. 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)

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

effects that weaken the impact of the policy.Example:• We have a recessionary gap• 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 12

5 Problems with Fiscal Policy

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5. 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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5 Problems with Fiscal Policy

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Review Activity

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Activity: Review CirclesYou will be given one key concept to focus on.You must understand it well enough to quiz and help others remember it. You must able to answer people’s questions and give clear examples.DON’T TEACH!!!!!!!!!! QUIZ your partners. Make them work to remember the concept.

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Review Circles

Odd numbers

Even Numbers

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1. Aggregate Demand2. Real Balance Effect3. Interest Rate Effect4. Foreign Trade Effect5. Shifters of AD

(C,I,G,X)6. Aggregate Supply7. Shifter of AS (R.A.P.)8. Short Run AS9. Long Run AS10.Two Types of Inflation 11.Ratchet Effect12.Classic vs. Keynesian13.Three Ranges of AS

List the 25 Concepts we have covered14. Fiscal Policy15. Discretionary vs. Non-

Discretionary16. Expansionary Policy17. Contractionary Policy18. The Car Analogy19. Multiplier Effect20. Calculating the

Spending Multiplier21. MPC and MPS22. Deficit Spending23. Timing Problems 24. Crowding-Out Effect25. Net Exports Effect 17