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Fiscal Policy and Economic Recovery Strategies

Chapter 13 discusses fiscal policy, deficits, and debt, focusing on the effects of changes in income and government spending on aggregate demand (AD) and output. It presents several examples illustrating how shifts in AD due to economic crises can be countered by government actions such as increasing spending or decreasing taxes. The chapter also explores the implications of running budget deficits and financing them through debt issuance.

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Joseph Ihsani
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4 views8 pages

Fiscal Policy and Economic Recovery Strategies

Chapter 13 discusses fiscal policy, deficits, and debt, focusing on the effects of changes in income and government spending on aggregate demand (AD) and output. It presents several examples illustrating how shifts in AD due to economic crises can be countered by government actions such as increasing spending or decreasing taxes. The chapter also explores the implications of running budget deficits and financing them through debt issuance.

Uploaded by

Joseph Ihsani
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Chapter 13

Fiscal Policy, Deficits, and Debt

Keyvan Eslami

Department of Economics
Toronto Metropolitan University
Example 1

• Suppose the marginal propensity to consume in an economy is 0.5. By how much and in what
direction does the AD initially shift in this economy if the income increases by $20 billion? What if
income decrease by $20 billion?
Example 2.1
• Suppose an economy is initially in equilibrium at point GDP1 and P1.
As a result of an unexpected crisis in the financial markets, the AD curve suddenly shift to the left by
a horizontal distance equal to $20 billion. How much will the output fall as a result of this shift in
demand?

$20b

Price level
AD1 AS
AD2

P1

GDP1 Real GDP


Example 2.2
• Suppose the government wants to counter the resulting recession by increasing its spending.
Assuming the marginal propensity to consume in this economy is 0.5, by how much must the
government increase its spending to restore the economy to its initial level of output? (For this part
of the question, you can ignore the fact that the government must somehow finance the resulting
budget deficit.)
$20b

Price level
AD1 AS
AD2

P1

GDP1 Real GDP


Example 2.3
• Suppose the government wants to counter the resulting recession by decreasing the taxes on
households. Assuming the marginal propensity to consume in this economy is 0.5, by how much
must the government decrease the taxes to restore the economy to its initial level of output? (For
this part of the question, you can ignore the fact that the government must somehow finance the
resulting budget deficit.)
$20b

Price level
AD1 AS
AD2

P1

GDP1 Real GDP


Example 2.4
• Suppose the government has decided to restore the economy to its initial level of output by running
a budget deficit (by either increasing its spending or decreasing taxes). How can the government
finance this budget deficit?

$20b

Price level
AD1 AS
AD2

P1

GDP1 Real GDP


Example 2.5
• Suppose the government has decided to restore the economy to its initial level of output by
simultaneously increasing its spending and increasing taxes (so that it does not run into a deficit). Is
this possible? If so, by how much must the government increase its spending?

$20b

Price level
AD1 AS
AD2

P1

GDP1 Real GDP


Example 2.6
• Suppose the government has decided to restore the economy to its initial level of output by
increasing its spending and paying for the resulting budget deficit by issuing debt. What do you think
will happen?

$20b

Price level
AD1 AS
AD2

P1

GDP1 Real GDP

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