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Principles of macroeconomics 10e by case fair oster ch09

PRINCIPLES OF

MACROECONOMICS

PART III The Core of Macroeconomic Theory

TENTH

EDITION

CASE FAIR OSTER

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

Prepared by: Fernando Quijano & Shelly
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PART III The Core of Macroeconomic Theory
© 2012 Pearson Education, Inc. Publishing as Prentice Hall


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The Government and
Fiscal Policy

9

CHAPTER OUTLINE
Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable
Income (Yd)
The Determination of Equilibrium Output (Income)

Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier
The Tax Multiplier
The Balanced-Budget Multiplier

PART III The Core of Macroeconomic Theory

The Federal Budget

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The Budget in 2009
Fiscal Policy Since 1993: The Clinton, Bush, and Obama
Administrations
The Federal Government Debt

The Economy’s Influence on the Government
Budget
Automatic Stabilizers and Destabilizers
Full-Employment Budget

Looking Ahead
Appendix A: Deriving the Fiscal Policy Multipliers
Appendix B: The Case in Which Tax Revenues
Depend on Income

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PART III The Core of Macroeconomic Theory

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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PART III The Core of Macroeconomic Theory

The behavior of the Federal Reserve concerning the nation’s
money supply is called:
a.
Discretionary fiscal policy.
b.
Automatic fiscal policy.
c.
Budgetary policy.
d.
Monetary policy.

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PART III The Core of Macroeconomic Theory

The behavior of the Federal Reserve concerning the nation’s
money supply is called:
a.
Discretionary fiscal policy.
b.
Automatic fiscal policy.
c.
Budgetary policy.
d.
Monetary policy.

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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.
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)

PART III The Core of Macroeconomic Theory

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.
disposable income ≡ total income − net taxes

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Yd ≡ Y − T

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PART III The Core of Macroeconomic Theory

Over which of the following categories does the government have
more control?
a.
Tax revenue.
b.
Government expenditures.
c.
Tax rates.
d.
The size of corporate profits.

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

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PART III The Core of Macroeconomic Theory

Over which of the following categories does the government have
more control?
a.
Tax revenue.
b.
Government expenditures.
c.
Tax rates.
d.
The size of corporate profits.

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)

PART III The Core of Macroeconomic Theory

 FIGURE 9.1 Adding Net Taxes
(T) and Government Purchases (G)
to the Circular Flow of Income

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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
The disposable income (Yd) of households must end up as either
consumption (C) or saving (S). Thus,

Yd ≡ C + S

PART III The Core of Macroeconomic Theory

Because disposable income is aggregate income (Y) minus net taxes
(T), we can write another identity:

Y − T ≡ C + S
By adding T to both sides:

Y ≡ C + S + T
Planned aggregate expenditure (AE) is the sum of consumption
spending by households (C), planned investment by business firms (I),
and government purchases of goods and services (G).

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AE ≡ C + I + G
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Select the best answer. Households use their disposable income
(Yd) to do the following:
Consume.
Consume and save.
Consume, save, and pay taxes.
Consume, save, pay taxes, and buy imports.

PART III The Core of Macroeconomic Theory

a.
b.
c.
d.

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Select the best answer. Households use their disposable income
(Yd) to do the following:
Consume.
Consume and save.
Consume, save, and pay taxes.
Consume, save, pay taxes, and buy imports.

PART III The Core of Macroeconomic Theory

a.
b.
c.
d.

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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.

PART III The Core of Macroeconomic Theory

budget deficit ≡ G − T

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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

PART III The Core of Macroeconomic Theory

C = a + bYd
or
C = a + b(Y − T)
Our consumption function now has consumption depending
on disposable income instead of before-tax income.

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

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PART III The Core of Macroeconomic Theory

When government enters the circular flow of income, which of the
following is an expression for planned aggregate expenditure?
a.
Y−T
b.
C+S+T
c.
C+I+G
d.
G–T

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PART III The Core of Macroeconomic Theory

When government enters the circular flow of income, which of the
following is an expression for planned aggregate expenditure?
a.
Y−T
b.
C+S+T
c.
C+I+G
d.
G–T

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Government in the Economy
Government Purchases (G), Net Taxes (T), and Disposable Income (Yd)
Planned Investment

PART III The Core of Macroeconomic Theory

The government can affect investment behavior through its
tax treatment of depreciation and other tax policies.

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Government in the Economy
The Determination of Equilibrium Output (Income)
Y=C+I+G

TABLE 9.1 Finding Equilibrium for I = 100, G = 100, and T = 100
(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

(10)

PART III The Core of Macroeconomic Theory

Unplanned
Planned
Planned
Disposable
Consumption
Saving
Inventory Adjustment
Output
Net
Investment Government Aggregate
Income
Spending
S
Change
(Income) Taxes
Spending Purchases Expenditure
to DisequiY
≡Y

T
C
=
100
+
.75
Y
Y

C
Y

(C + I + G)
Y
T
I
G
C+I+G
librium
d
d
d

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

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 ↓

© 2012 Pearson Education, Inc. Publishing as Prentice Hall

Equilibrium

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Government in the Economy
The Determination of Equilibrium Output (Income)
 FIGURE 9.2 Finding Equilibrium
Output/Income Graphically

PART III The Core of Macroeconomic Theory

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.

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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:

PART III The Core of Macroeconomic Theory

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:

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S+T=I+G
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PART III The Core of Macroeconomic Theory

In the circular flow that includes households, firms, and
government, which of the following expressions is the
leakages/injections approach to equilibrium?
a.
Y = C + I + G.
b.
C + S = I + G.
c.
Y = a + bT + I + G.
d.
S + T = I + G.

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PART III The Core of Macroeconomic Theory

In the circular flow that includes households, firms, and
government, which of the following expressions is the
leakages/injections approach to equilibrium?
a.
Y = C + I + G.
b.
C + S = I + G.
c.
Y = a + bT + I + G.
d.
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

PART III The Core of Macroeconomic Theory

Balanced-budget multiplier

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Fiscal Policy at Work: Multiplier Effects
The Government Spending Multiplier

government spending multiplier =

1
MPS

PART III The Core of Macroeconomic Theory

government spending multiplier The ratio of the change in the
equilibrium level of output to a change in government spending.

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