Macroeconomics

‭The‬ ‭long-term‬ ‭serious‬ ‭effect‬ ‭of‬ ‭crowding‬ ‭out‬ ‭is‬ ‭slower‬ ‭economic‬ ‭growth‬ ‭.‬ ‭Recall‬ ‭from‬ ‭Chapter‬ ‭1‬ ‭Section‬‭E:‬‭Shifts‬‭of‬‭the‬‭PPC,‬‭that‬‭economic‬‭growth‬‭is‬‭reflected‬‭by‬‭an‬‭outward‬‭shift‬‭of‬‭the‬‭PPC‬‭that‬‭results‬ ‭either‬ ‭from‬ ‭an‬ ‭increase‬ ‭in‬ ‭the‬ ‭economy’s‬ ‭productive‬ ‭capacity‬ ‭because‬ ‭more‬ ‭resources‬ ‭become‬ ‭available,‬ ‭or‬ ‭due‬ ‭to‬ ‭technological‬ ‭advancements.‬ ‭When‬ ‭private‬ ‭investment‬ ‭decreases,‬ ‭capital‬ ‭accumulation or capital stock decreases,‬ ‭hence slowing‬‭down economic growth.‬ ‭In‬ ‭summary,‬ ‭an‬ ‭expansionary‬ ‭fscal‬ ‭policy‬ ‭that‬ ‭includes‬ ‭running‬ ‭a‬ ‭budget‬ ‭defcit‬ ‭could‬ ‭lead‬ ‭to‬ ‭crowding out which in turn has a long-term effect of reducing economic growth‬ ‭.‬ ‭E. Automatic Stabilizers‬ ‭Fiscal‬ ‭policies‬ ‭have‬ ‭lags‬ ‭that‬ ‭prevent‬ ‭them‬ ‭from‬ ‭quickly‬ ‭smoothing‬ ‭out‬ ‭fluctuations‬ ‭in‬ ‭the‬ ‭business‬ ‭cycle.‬ ‭However,‬ ‭some‬ ‭existing‬ ‭laws‬ ‭or‬ ‭policies‬ ‭are‬ ‭non-discretionary‬ ‭(not‬ ‭explicitly‬ ‭done‬ ‭by‬ ‭the‬ ‭government‬ ‭to‬ ‭solve‬ ‭economic‬ ‭problems)‬ ‭and‬ ‭help‬ ‭restore‬ ‭the‬‭economy‬‭to‬‭equilibrium‬‭without‬‭active‬ ‭involvement‬‭of‬‭governments‬‭or‬‭authorities.‬‭These‬‭things‬‭are‬‭referred‬‭as‬ ‭automatic‬‭stabilizers‬ ‭or‬ ‭built-in‬ ‭stabilizers‬ ‭and include the following:‬ ‭1.‬ ‭Taxes:‬ ‭Let’s‬‭assume‬‭that‬‭an‬‭economy‬‭uses‬‭a‬ ‭progressive‬‭tax‬‭system‬ ‭.‬‭This‬‭means‬‭that‬‭the‬‭tax‬ ‭rate‬ ‭paid‬ ‭increases‬ ‭as‬ ‭income‬ ‭increases‬ ‭(e.g.,‬ ‭those‬ ‭who‬ ‭earn‬ ‭less‬ ‭than‬ ‭$10,000‬ ‭pay‬ ‭2%‬ ‭in‬ ‭income tax, whereas those who earn more than $10,000 pay 8% in income tax)‬ ‭.‬ ‭In‬‭times‬‭of‬‭economic‬‭downturn,‬‭people’s‬‭disposable‬‭incomes‬‭decrease‬‭(e.g.,‬‭due‬‭to‬‭pay‬‭cuts).‬‭If‬ ‭worker‬ ‭A’s‬ ‭income‬ ‭drops‬ ‭from‬ ‭$12,000‬ ‭to‬ ‭$8,000,‬ ‭the‬ ‭amount‬ ‭of‬ ‭tax‬ ‭worker‬ ‭A‬ ‭pays‬ ‭will‬ ‭automatically‬ ‭drop‬‭from‬‭$960‬‭to‬‭$160‬‭(8%‬‭of‬‭$12,000‬‭vs.‬‭2%‬‭of‬‭$8,000).‬‭This‬‭works‬‭the‬‭same‬ ‭as‬ ‭an‬ ‭increase‬ ‭in‬ ‭worker‬ ‭A’s‬ ‭disposable‬ ‭income;‬ ‭meaning‬ ‭that‬ ‭this‬ ‭automatic‬ ‭change‬ ‭in‬ ‭the‬ ‭amount‬ ‭of‬ ‭taxes‬ ‭paid‬ ‭acts‬ ‭like‬ ‭an‬ ‭expansionary‬ ‭fscal‬ ‭policy‬ ‭where‬ ‭taxes‬ ‭are‬ ‭reduced‬ ‭to‬ ‭stimulate‬ ‭consumption‬ ‭and/or‬ ‭investments,‬ ‭and‬ ‭hence‬ ‭aggregate‬ ‭demand!‬ ‭Note‬ ‭how‬ ‭the‬

‭government‬ ‭did‬ ‭not‬ ‭intervene‬ ‭in‬ ‭this‬ ‭case.‬ ‭The‬ ‭progressive‬ ‭tax‬ ‭system‬‭was‬‭already‬‭set‬‭in‬‭place‬‭before‬ ‭any changes in the business cycle.‬ ‭Alternatively,‬ ‭in‬ ‭times‬ ‭of‬ ‭economic‬ ‭boom‬ ‭where‬ ‭real‬ ‭GDP‬‭is‬‭high‬‭and‬‭more‬‭people‬‭are‬‭paying‬‭higher‬‭income‬ ‭taxes,‬ ‭tax‬ ‭revenue‬ ‭increases.‬ ‭This‬ ‭reduces‬ ‭disposable‬ ‭incomes‬ ‭and‬ ‭helps‬ ‭in‬ ‭controlling‬ ‭consumption‬ ‭and‬ ‭preventing inflation from increasing further.‬

‭2.‬ ‭Transfer‬‭Payments:‬ ‭Recall‬‭that‬‭transfer‬‭payments‬‭are‬‭payments‬‭received‬‭without‬‭the‬‭exchange‬ ‭of‬‭a‬‭good‬‭or‬‭service,‬‭such‬‭as‬‭welfare‬‭payments‬‭and‬‭unemployment‬‭benefts.‬‭During‬‭recessions,‬ ‭more‬ ‭people‬ ‭are‬ ‭unemployed‬‭and,‬‭therefore,‬‭receive‬‭unemployment‬‭benefts.‬‭This‬‭means‬‭that‬ ‭consumption‬ ‭will‬ ‭drop,‬‭but‬‭the‬‭role‬‭of‬‭unemployment‬‭benefts‬‭will‬‭absorb‬‭some‬‭of‬‭that‬‭impact‬ ‭as‬‭they‬‭act‬‭as‬‭a‬‭means‬‭for‬‭people‬‭to‬‭spend.‬‭Alternatively,‬‭in‬‭times‬‭of‬‭booms,‬‭less‬‭people‬‭receive‬ ‭unemployment‬ ‭benefts‬ ‭because‬ ‭the‬ ‭unemployment‬ ‭rate‬ ‭is‬ ‭usually‬ ‭low.‬ ‭This‬ ‭is‬ ‭basically‬ ‭a‬ ‭reduction‬ ‭in‬ ‭government‬ ‭spending‬ ‭which‬ ‭in‬ ‭turn‬ ‭reduces‬ ‭aggregate‬ ‭demand‬ ‭(shifts‬ ‭AD‬ ‭to‬ ‭the‬ ‭left) and aids in reducing the price levels.‬

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