Economics book slide Case and Fair a good path to learn basics of economics

1. CHATheGovernmentan
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PowerPoint Lectures for
Principles of Economics,
9e
By
Karl E. Case,
Ray C. Fair &
Sharon M. Oster
; ;

2. CHATheGovernmentan
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3. © 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster
PART V THE CORE OF MACROECONOMIC
THEORY
24The Government
and Fiscal Policy
Fernando & Yvonn Quijano
Prepared by:

4. CHATheGovernmentan
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24
Government in the Economy
Government Purchases (G), Net Taxes (T),
and Disposable income (Y d)
The Determination of Equilibrium Output
(Income)
Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
The Tax Multiplier
The Balanced-Budget Multiplier
The Federal Budget
The Budget in 2007
Fiscal Policy Since 1993: The Clinton and
Bush Administrations
The Federal Government Debt
The Economy’s Influence on the
Government Budget
Tax Revenues Depend on the State of the
Economy
Some Government Expenditures Depend on the
State of the Economy
Automatic Stabilizers
Fiscal Drag
Full-Employment Budget
Looking Ahead
Appendix A: Deriving the Fiscal Policy
Multipliers
Appendix B: The Case in Which Tax Revenues
Depend on Income
CHAPTER OUTLINE
The Government
and Fiscal Policy
PART V THE CORE OF MACROECONOMIC
THEORY

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The Government and Fiscal Policy
fiscal policy The government’s spending and
taxing policies.
monetary policy The behavior of the Federal
Reserve concerning the nation’s money supply.

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Government in the Economy
discretionary fiscal policy Changes in taxes or
spending that are the result of deliberate changes
in government policy.
net taxes (T) Taxes paid by firms and households
to the government minus transfer payments made
to households by the government.
disposable, or after-tax, income (Yd) Total
income minus net taxes: Y - T.
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
disposable income ≡ total income − net taxes
Yd ≡ Y − T

7. CHATheGovernmentan
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
 FIGURE 24.1 Adding Net
Taxes (T) and Government
Purchases (G) to the
Circular Flow of Income

8. CHATheGovernmentan
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
When government enters the picture, the
aggregate income identity gets cut into three
pieces:
Y Y Td ≡ −
Y C Sd ≡ +
Y T C S− ≡ +
Y C S T≡ + +
And aggregate expenditure (AE) equals:
AE C I G= + +

9. CHATheGovernmentan
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
budget deficit The difference between what a
government spends and what it collects in taxes in
a given period: G - T.
budget deficit ≡ G − T

10. CHATheGovernmentan
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
Adding Taxes to the Consumption Function
To modify our aggregate consumption function to
incorporate disposable income instead of before-
tax income, instead of C = a + bY, we write
C = a + bYd
or
C = a + b(Y − T)
Our consumption function now has consumption
depending on disposable income instead of
before-tax income.

11. CHATheGovernmentan
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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
Planned Investment
The government can affect investment behavior
through its tax treatment of depreciation and other
tax policies.

12. CHATheGovernmentan
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Government in the Economy
The Determination of Equilibrium Output (Income)
Y = C + I + G
TABLE 24.1 Finding Equilibrium for I = 100, G = 100, and T = 100
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Output
(Income)
Y
Net
Taxes
T
Disposable
Income
Yd Y − T
Consumption
Spending
(C = 100 + .75 Yd)
Saving
S
(Yd – C)
Planned
Investment
Spending
I
Government
Purchases
G
Planned
Aggregate
Expenditure
C + I + G
Unplanned
Inventory
Change
Y − (C + I + G)
Adjustment
to Disequi-
librium
300 100 200 250 − 50 100 100 450 − 150 Output
500 100 400 400 0 100 100 600 − 100 Output
700 100 600 550 50 100 100 750 − 50 Output
900 100 800 700 100 100 100 900 0 Equilibrium
1,100 100 1,000 850 150 100 100 1,050 + 50 Output
1,300 100 1,200 1,000 200 100 100 1,200 + 100 Output
1,500 100 1,400 1,150 250 100 100 1,350 + 150 Output

13. CHATheGovernmentan
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Government in the Economy
The Determination of Equilibrium Output (Income)
 FIGURE 24.2 Finding Equilibrium
Output/Income Graphically
Because G and I are both fixed
at 100, the aggregate
expenditure function is the new
consumption function displaced
upward by I + G = 200.
Equilibrium occurs at Y = C + I +
G = 900.

14. CHATheGovernmentan
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Government in the Economy
The Determination of Equilibrium Output (Income)
The Saving/Investment Approach to Equilibrium
saving/investment approach to equilibrium:
S + T = I + G
To derive this, we know that in equilibrium,
aggregate output (income) (Y) equals planned
aggregate expenditure (AE). By definition, AE
equals C + I + G; and by definition, Y equals
C + S + T. Therefore, at equilibrium
C + S + T = C + I + G
Subtracting C from both sides leaves:
S + T = I + G

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Fiscal Policy at Work: Multiplier Effects
At this point, we are assuming that the government
controls G and T. In this section, we will review
three multipliers:
Government spending multiplier
Tax multiplier
Balanced-budget multiplier

16. CHATheGovernmentan
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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
1
government spending multiplier
MPS
=
government spending multiplier The ratio of the
change in the equilibrium level of output to a
change in government spending.

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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
TABLE 24.2 Finding Equilibrium After a Government Spending Increase of 50 (G Has
Increased from 100 in Table 24.1 to 150 Here)
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Output
(Income)
Y
Net
Taxes
T
Disposable
Income
Yd Y − T
Consumption
Spending
(C = 100 + .75 Yd)
Saving
S
(Yd – C)
Planned
Investment
Spending
I
Government
Purchases
G
Planned
Aggregate
Expenditure
C + I + G
Unplanned
Inventory
Change
Y − (C + I + G)
Adjustment
To
Disequilibrium
300 100 200 250 − 50 100 150 500 − 200 Output
500 100 400 400 0 100 150 650 − 150 Output
700 100 600 550 50 100 150 800 − 100 Output
900 100 800 700 100 100 150 950 − 50 Output
1,100 100 1,000 850 150 100 150 1,100 0 Equilibrium
1,300 100 1,200 1,000 200 100 150 1,250 + 50 Output

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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
 FIGURE 24.3 The Government
Spending Multiplier
Increasing government spending by
50 shifts the AE function up by 50.
As Y rises in response, additional
consumption is generated.
Overall, the equilibrium level of Y
increases by 200, from 900 to
1,100.

19. CHATheGovernmentan
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Fiscal Policy at Work: Multiplier Effects
The Tax Multiplier
tax multiplier The ratio of change in the
equilibrium level of output to a change in taxes.
( )tax multiplier
MPC
MPS
≡ −
∆ Y
M P S
= ×





( i n i t i a l i n c r e a s e i n a g g r e g a t e e x p e n d i t u r e )
1
1
( )
MPC
Y T MPC T
MPS MPS
∆ = − ∆ × × = −∆ ×
   
 ÷  ÷
   

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Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
balanced-budget multiplier The ratio of change
in the equilibrium level of output to a change in
government spending where the change in
government spending is balanced by a change in
taxes so as not to create any deficit. The
balanced-budget multiplier is equal to 1: The
change in Y resulting from the change in G and the
equal change in T are exactly the same size as the
initial change in G or T.
1balanced-budget multiplier ≡

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Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
TABLE 24.3 Finding Equilibrium After a Balanced-Budget Increase in G and T of 200 Each
(Both G and T Have Increased from 100 in Table 24.1 to 300 Here)
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Output
(Income)
Y
Net
Taxes
T
Disposable
Income
Yd Y − T
Consumption
Spending
(C = 100 + .75 Yd)
Planned
Investment
Spending
I
Government
Purchases
G
Planned
Aggregate
Expenditure
C + I + G
Unplanned
Inventory
Change
Y − (C + I + G)
Adjustment
To
Disequilibrium
500 300 200 250 100 300 650 − 150 Output
700 300 400 400 100 300 800 − 100 Output
900 300 600 550 100 300 950 − 50 Output
1,100 300 800 700 100 300 1,100 0 Equilibrium
1,300 300 1,000 850 100 300 1,250 + 50 Output
1,500 300 1,200 1,000 100 300 1,400 + 100 Output

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Fiscal Policy at Work: Multiplier Effects
The Balanced-Budget Multiplier
TABLE 24.4 Summary of Fiscal Policy Multipliers
Policy Stimulus Multiplier
Final Impact On
Equilibrium Y
Government
spending
multiplier
Increase or decrease in the
level of government
purchases: ∆G
Tax multiplier Increase or decrease in the
level of net taxes: ∆T
Balanced-
budget
multiplier
Simultaneous balanced-budget
increase or decrease in the
level of government purchases
and net taxes: ∆G = ∆T
1
1
M P S
− M P C
M P S
1
G
MPS
∆ ×
MPC
T
MPS
−
∆ ×
∆ G

23. CHATheGovernmentan
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The Federal Budget
federal budget The budget of the federal
government.
The “budget” is really three different budgets.
First, it is a political document that dispenses
favors to certain groups or regions and places
burdens on others.
Second, it is a reflection of goals the government
wants to achieve.
Third, the budget may be an embodiment of some
beliefs about how (if at all) the government should
manage the macroeconomy.

24. CHATheGovernmentan
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The Federal Budget
The Budget in 2007
TABLE 24.5 Federal Government Receipts and Expenditures, 2007 (Billions of Dollars)
Amount Percentage Of Total
Receipts
Personal income taxes 1,162.1 43.5
Excise taxes and customs duties 99.9 3.7
Corporate income taxes 380.8 14.3
Taxes from the rest of the world 13.4 0.5
Contributions for social insurance 953.0 35.7
Interest receipts and rents and royalties 25.1 0.9
Current transfer receipts from business and persons 39.4 1.5
Current surplus of government enterprises − 2.3 − 0.0
Total 2,671.4 100.0
Current Expenditures
Consumption expenditures 856.0 29.6
Transfer payments to persons 1,270.7 43.9
Transfer payments to the rest of the world 38.6 1.3
Grants-in-aid to state and local governments 377.5 13.1
Interest payments 302.4 10.5
Subsidies 46.7 1.6
Total 2,892.0 100.0
Net federal government saving—surplus (+) or deficit (−)
(Total current receipts − Total current expenditures) − 220.6
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

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The Federal Budget
The Budget in 2007
federal surplus (+) or deficit (−) Federal
government receipts minus expenditures.

26. CHATheGovernmentan
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The Federal Budget
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 24.4 Federal Personal Income Taxes as a Percentage of Taxable Income, 1993 I–2007 IV

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The Federal Budget
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 24.5 Federal Government Consumption Expenditures as a Percentage of GDP and
Federal Transfer Payments and Grants-in-Aid as a Percentage of GDP, 1993 I–2007 IV

28. CHATheGovernmentan
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The Federal Budget
Fiscal Policy Since 1993: The Clinton and Bush Administrations
 FIGURE 24.6 The Federal Government Surplus (+) or Deficit (–) as a Percentage of GDP,
1993 I–2007 IV

29. CHATheGovernmentan
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The Federal Budget
The Federal Government Debt
federal debt The total amount owed by the
federal government.
privately held federal debt The privately held
(non-government-owned) debt of the U.S.
government.

30. CHATheGovernmentan
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The Federal Budget
The Federal Government Debt
 FIGURE 24.7 The Federal Government Debt as a Percentage of GDP, 1993 I–2007 IV

31. CHATheGovernmentan
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The Economy’s Influence on the Government Budget
Tax Revenues Depend on the State of the Economy
Tax revenue, on the other hand, depends on
taxable income, and income depends on the state
of the economy, which the government does not
completely control.
Some Government Expenditures Depend on the State of the
Economy
Transfer payments tend to go down automatically
during an expansion.
Inflation often picks up when the economy is
expanding. This can lead the government to spend
more than it had planned to spend.
Any change in the interest rate changes
government interest payments.

32. CHATheGovernmentan
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The Economy’s Influence on the Government Budget
Some Government Expenditures Depend on the State of the
Economy
Fiscal Policy In 2008
Congress Approves
Economic-Stimulus Bill
Wall Street Journal

33. CHATheGovernmentan
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The Economy’s Influence on the Government Budget
Automatic Stabilizers
automatic stabilizers Revenue and expenditure
items in the federal budget that automatically
change with the state of the economy in such a
way as to stabilize GDP.
Fiscal Drag
fiscal drag The negative effect on the economy
that occurs when average tax rates increase
because taxpayers have moved into higher income
brackets during an expansion.

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The Economy’s Influence on the Government Budget
Full-Employment Budget
full-employment budget What the federal
budget would be if the economy were producing at
the full-employment level of output.
structural deficit The deficit that remains at full
employment.
cyclical deficit The deficit that occurs because of
a downturn in the business cycle.

35. CHATheGovernmentan
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automatic stabilizers
balanced-budget multiplier
budget deficit
cyclical deficit
discretionary fiscal policy
disposable, or after-tax,
income (Yd)
federal budget
federal debt
federal surplus (+) or deficit (−)
fiscal drag
fiscal policy
full-employment budget
government spending multiplier
monetary policy
REVIEW TERMS AND CONCEPTS
net taxes (T)
privately held federal debt
structural deficit
tax multiplier
1. Disposable income Yd ≡ Y − T
2. AE ≡ C + I + G
3. Government budget deficit ≡ G − T
4. Equilibrium in an economy with
government: Y = C + I + G
5. Saving/investment approach to
equilibrium in an economy with
government: S + T = I + G
6. Government spending multiplier ≡
7. Tax multiplier ≡
8. Balanced-budget multiplier ≡ 1
MPC
MPS
 
− ÷
 
MPS
1

36. CHATheGovernmentan
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DERIVING THE FISCAL POLICY MULTIPLIERS
A P P E N D I X A
THE GOVERNMENT SPENDING AND TAX MULTIPLIERS
Y C I G= + +
C a b Y T= + −( )
Y a b Y T I G= + − + +( )
Y a b Y b T I G= + − + +
Y b Y a I G b T− = + + −
Y b a I G b T( )1 − = + + −
( )
)(
1
1
bTGIa
b
Y −++
−
=

37. CHATheGovernmentan
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DERIVING THE FISCAL POLICY MULTIPLIERS
THE BALANCED-BUDGET MULTIPLIER
The balanced-budget multiplier is found by
combining the effects of government spending and
taxes:
G∆increase in spending:
( )C T MPC∆ = ∆- decrease in spending:
( )G T MPC∆ − ∆= net increase in spending
In a balanced-budget increase, ΔG = ΔT; so we can
substitute:
net initial increase in spending:
ΔG − ΔG (MPC) = ΔG (1 − MPC)
A P P E N D I X A

38. CHATheGovernmentan
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DERIVING THE FISCAL POLICY MULTIPLIERS
THE BALANCED-BUDGET MULTIPLIER
A P P E N D I X A
1
( )Y G MPS G
MPS
 
∆ = ∆ = ∆ ÷
 
Because MPS = (1 − MPC), the net initial increase
in spending is:
ΔG (MPS)
We can now apply the expenditure multiplier
to this net initial increase in spending:






MPS
1

39. CHATheGovernmentan
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THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
A P P E N D I X B
TYYd −≡
)3/1200( YYYd +−−≡
YYYd 3/1200 −+≡
dYC 75.100 +=
)3/1200(75.100 YYC −++=
 FIGURE 24B.1 The Tax Function

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THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
A P P E N D I X B
When taxes are strictly lump-sum (T =
100) and do not depend on income,
the aggregate expenditure function is
steeper than when taxes depend on
income.
 FIGURE 24B.2 Different Tax
Systems
GICY ++=
{ {100 .75( 200 1/3 ) 100 100Y Y Y
I GC
= + + − + +
14444244443
4505.
5.450
10010025.15075.100
=
+=
++−++=
Y
YY
YYY

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THE CASE IN WHICH TAX REVENUES DEPEND ON INCOME
A P P E N D I X B
THE GOVERNMENT SPENDING AND TAX MULTIPLIERS ALGEBRAICALLY
C a b Y T= + −( )
0C a bY bT btY= + − −
0( )C a b Y T tY= + − −
0
Y a bY bT btY I G
C
= + − − + +
144424443
Y
b b t
a I G b T=
− +
+ + −
1
1 0( )
1
1 b bt− +