Macroeconomics

‭policy‬ ‭aiming‬ ‭to‬ ‭increase‬‭AD‬‭(shifting‬‭its‬‭curve‬‭to‬‭the‬‭right)‬‭until‬‭the‬‭short-run‬‭equilibrium‬‭reaches‬‭the‬ ‭full‬‭employment‬‭level‬‭(intersection‬‭of‬‭AD-SRAS-LRAS).‬‭Consequently,‬‭this‬‭policy‬‭can‬‭lead‬‭to‬‭inflation‬‭as‬ ‭unemployment decreases and output increases.‬ ‭The‬ ‭expansionary‬ ‭fscal‬ ‭policy‬ ‭tools‬ ‭that‬ ‭increase‬ ‭aggregate‬ ‭demand‬ ‭are‬ ‭increasing‬ ‭government‬ ‭spending and decreasing taxes.‬

‭The‬ ‭impact‬ ‭of‬ ‭an‬ ‭increase‬ ‭in‬ ‭government‬ ‭spending‬ ‭on‬ ‭aggregate‬ ‭demand‬ ‭is‬ ‭direct‬ ‭since‬ ‭G‬ ‭is‬ ‭a‬ ‭component‬ ‭of‬ ‭AD.‬ ‭However,‬ ‭a‬ ‭decrease‬ ‭in‬ ‭taxes‬ ‭has‬ ‭an‬ ‭indirect‬ ‭effect‬ ‭on‬ ‭AD‬ ‭because‬ ‭it‬ ‭increases‬ ‭households’‬ ‭disposable‬ ‭incomes‬ ‭and/or‬ ‭frms’‬ ‭profts.‬ ‭Consequently,‬ ‭consumption‬ ‭and/or‬ ‭investment‬ ‭increase, resulting in a rightward shift of the AD curve.‬

‭↑G → AD ↑ → real GDP ↑ → price level ↑‬ ‭and/or‬

‭↓T → C ↑ and/or I↑ → AD ↑ → real GDP ↑ → price level ↑‬

‭Study Tip‬ ‭Do‬‭not‬‭confuse‬‭fscal‬‭with‬‭monetary‬‭policy.‬‭An‬‭increase‬‭in‬‭government‬‭spending,‬ ‭ceteris‬‭paribus‬ ‭,‬‭does‬ ‭not‬ ‭affect‬ ‭money‬ ‭supply;‬ ‭it‬ ‭affects‬ ‭aggregate‬ ‭demand.‬ ‭Changes‬ ‭in‬ ‭money‬ ‭supply‬ ‭are‬ ‭caused‬ ‭by‬ ‭monetary policy tools.‬ ‭Contractionary Fiscal Policy‬ ‭In‬ ‭times‬ ‭of‬ ‭peak,‬ ‭economies‬ ‭may‬ ‭experience‬ ‭inflation‬ ‭reflected‬ ‭by‬ ‭an‬ ‭inflationary‬ ‭gap‬ ‭on‬ ‭the‬ ‭AD-AS‬ ‭model.‬ ‭This‬ ‭means‬ ‭that‬ ‭the‬ ‭short-run‬ ‭equilibrium‬ ‭is‬ ‭above‬ ‭the‬ ‭full‬ ‭employment‬ ‭level‬ ‭resulting‬ ‭in‬ ‭inflationary‬ ‭pressures.‬ ‭Recall‬ ‭that‬ ‭demand-pull‬ ‭inflation‬ ‭is‬ ‭a‬ ‭general‬ ‭increase‬ ‭in‬ ‭the‬ ‭price‬ ‭level‬ ‭caused‬‭by‬‭excessive‬‭aggregate‬‭demand‬ ‭that‬‭cannot‬‭be‬‭met‬‭with‬‭the‬‭current‬‭production‬‭levels.‬‭To‬‭close‬

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