2. MACRO-ECONOMIC OBJECTIVES
๏ Employment levels -> High
๏ Price levels -> Stable
๏ Output of G/S -> Increases Over time
๏ NI -> Distributed in an equitable manner.
To Achieve Macro-economic objectives:
Macro-economic policies:
๏ Fiscal Policy
๏ Monetary Policy
๏ Supply-side policies
3. FISCAL POLICY
๏ Govt changes level of Taxation and/or level
of Govt Spending. Promote ->
Macroeconomic obj.
โขY-> Y(FE) -> Full
employment
โขP-> Pe -> Stable
price level
โขIncreasing rGDP. -
> Economic growth
4. DEFICITS, SURPLUS AND DEBTS
๏ Govt tot expenditure exceed total tax revenue ->
Budget Deficit
๏ Deficit paid -> Borrowing from public (Explored
in further chapters).
๏ When govt borrow -> National Debt
(Accumulation of deficits from past
years)increases.
๏ Govt tax revenue exceeds expenditure ->
Budget Surplus -> Reduces national debt
๏ Tax revenue = Govt expenditure -> Balanced
budget
5. AUTOMATIC FISCAL POLICY
๏ Tax and govt spending s/ms -> element of
bui;t in stability.
๏ Increase in GDP -> Decrease in G and
Increase in T
๏ Decrease in GDP -> Increase in G and
Decrease in T
6. PERIODS OF ECONOMICS GROWTH:
๏ Y> Yfe, unemp->low, households and firms
income and revenues-> high, Decrease in govtโs
expenditures on certain items. Few ppl
collecting benefits -> unemp, welfare,
subsidized food etc..
๏ Healthcare -> provided by public n pvt, unemp -
> low, govt spend less on healthcare. Employers
cover health benefits.
๏ Growth in a nationโs GDP -> Increase tax
revenues due in increased income and
expenditure by households and firms.
7. DISCRETIONARY FISCAL POLICY
๏ At the discretion (Decision of policy makers).
๏ Change in T and G undertaken by govt with
the explicit aim of either stimulating /
contracting the overall level of Demand in the
economy to promote Economic stabilty and
full employment
8. ๏ Increase level of AD/AS -> Expansionary
Fiscal Policy
๏ Decrease level of AD/AS -> Conntractionary
Fiscal policy
๏ Expansion:
Increase AD, By Decreasing Taxes and
Increasing Govt Spending
๏ Contraction:
Decrease AD, By Increasing Taxes and
Decreasing Govt Spending
9. EXPANSIONARY FISCAL POLICY
๏ Dec in Consumption
and Income ->
Decrease in AD
๏ Price levels -> Come
down (Deflation).
๏ Decrease in National
O/P -> Recession ->
Increased
Unemployment.
๏ Govt needs to intervene.
10. EXPANSIONARY FISCAL POLICY
๏ Decrease Taxes:
Decrease IT -> Increase Disposable Income ->
Increase C -> Increase AD
๏ Increase Govt Spending (G):
Increase Public goods, defence, edn and
healthcare, Increase AD
After โEffects:
๏ Price Levels Increase -> Stable
๏ Increase O/P -> Full employment
๏ Unemp Decreases.
12. CONTRACTIONARY FISCAL POLICY
๏ Increase Taxes
Increase IT -> Decrease Disposable Income-> C
Decreases -> Decrease in AD
๏ Decrease G
Reduce public goods, defence -> AD Decreases.
After-Effects:
๏ Price levels Come down -> Stable
๏ O/P Reduces and comes to full employment
level.
๏ Unemployment Increases to the desirable state.
13. THE MULTIPLIER EFFECT: HL
๏ THE GOVT
SPENDING
MULTIPLIER (The
Keynesian
Spending
Multiplier):
๏ Recessionary Gap,
๏ Y < Yfe, P2 < P1 โ
Deflation
๏ Expansionary: Inc G
and Dec T
14. THE GOVT SPENDING MULTIPLIER (THE
KEYNESIAN SPENDING MULTIPLIER):
๏ Increase in G -> Increase in AD (How many
times).
๏ G-> Multiplied greater expansionary effect on
AD
๏ Eg. If G inc by $ 1b, AD Inc by $ 4b
๏ ๏ Multiplier of 4
๏Depends on Macroecon variables โ
๏Marginap Propensity to Save and Consume
๏Households -> Either Spend/Save any change
in Income
15. MARGINAL PROPENSITY TO CONSUME
๏ MPC ๏ โC
โY
Changes in G -> Changes in o/p
G inc by $1b -> Y inc by $1b
C Inc by $ 400 m
MPC ๏ 400/1000 = 0.4
If thereโs a inc in Y of $1 ๏ Consumption
increases by 40 cents.
16. MARGINAL RATE OF LEAKAGE (MRL)
๏ MRL = MPS + MPM + MRT
๏ MPS -> Marginal propensity to Save (โS/โY)
๏ MPM -> Marginal propensity to Imports (โM/โY)
๏ MRT -> Marginal Rate of Tax(โT/โY)
๏ MRL ๏ Proportion of Income that goes into
purchase of Leakages(Imports, Savings, Taxes).
๏ MPC + MRL =1
๏ MRL = 1-MPC
๏ Above eg: MRL = 1-0.4 = 0.6
17. THE KEYNESIAN GOVT SPENDING MULTIPLIER
(K)
๏ K = 1 = 1
1-MPC MRL
Larger the MPC, Larger the value of K,
Above eg, MPC = 0.4, MRL =0.6, K = 1.67
Inc in G ๏ Increases AD by 1.67 times
Eg. If G increases by $ 1b -> AD will Increase
by K(โG) => 1.67 * $1b => $1.67b
18. ILLUSTRATION
Take before example
Recessionary gap is $ 5b.
AD increases by $ 1.67b doesnโt cover
the Gap
To Cover Gap, AD should increase by $
5b
โG * K = โAD
If โAD = $ 5b, โG => $ 5b/ K = $ 3b
Hence, To fill the gap of $ 5b -> G should
increase by $ 3b, Higher Fiscal Stimulus
Fiscal Stimulus:
How much should G be changed to
cover the gap of recession.
19. K MPC MRL
Larger Higher Smaller
Smaller Lower Higher
Evaluation of Fiscal policy:
โขGovt Spending Vs tax cuts
Reduction in T of a particular amount is less effective at
Increasing NI than Increasing G
G ๏ direct injunction into circular flow of income. Tax cut is
an indirect injunction into the circular flow of income
Instead of G spending, govt cuts taxes by $ 3b=> MPC ->
0.6 of $ 3b ๏ $ 1.8 b will convert to new spending in the
economy, rem 40% ($ 1.2b)leaked from the system
(savings, purchase of imports)
Hence AD will increase by 1.67 * $ 1.8b => $ 3b having still
a recession gap of (5-3) => $ 2b
20. STRENGTHS & WEAKNESSES OF FISCAL POLICY
๏ The crowding-out effect:
The effect of pvt consumption and investment
of a deficit-financed increase in govt
spending that leads to increase in interest
rates
i.e. When G inc -> Govt borrowing from pvt Inc
-> Drive up interest rates.
Inc in AD intended thro fiscal stimulus ->
crowded out by simultaneous Dec in
Consumption and Investment.
21. ๏ Nationsโ s loanable funds
mkt-> Money in Commercial
banks that is available to be
loaned out to firms &
households to finance pvt
investment and
consumption.
๏ Price of loanable funds ->
Real interest rate
๏ Real returns on savings and
real price on borrowings. Pvt
sectorโs willingness to save
and invest
๏ Supply curve -> savings,
Demand curve ->
Investment.
22. ๏ Higher real interest, Increase savings ->
more ROR. Direct relationship between real
interest & supply of loanable funds
๏ At lower interest rates, households & firms
borrow and spend Demand for loanable
funds reflect inverse relationship b/w QD and
real interest rates.