Chapter 34

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VNP-Econ-Chapter 34
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34-2f Changes in Taxes

The other important instrument of fiscal policy, besides the level of government purchases, is the level of taxation. When the government cuts personal income taxes, for instance, it increases households’ take-home pay. Households will save some of this additional income, but they will also spend some of it on consumer goods. Because it increases consumer […]

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34-2e The Crowding-Out Effect

The multiplier effect seems to suggest that when the government buys $20 billion of planes from Boeing, the resulting expansion in aggregate demand is necessarily larger than $20 billion. Yet another effect works in the opposite direction. While an increase in government purchases stimulates the aggregate demand for goods and services, it also causes the interest rate […]

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34-2d Other Applications of the Multiplier Effect

Because of the multiplier effect, a dollar of government purchases can generate more than a dollar of aggregate demand. The logic of the multiplier effect, however, is not restricted to changes in government purchases. Instead, it applies to any event that alters spending on any component of GDP—consumption, investment, government purchases, or net exports. For […]

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34-2c A Formula for the Spending Multiplier

Some simple algebra permits us to derive a formula for the size of the multiplier effect that arises when an increase in government purchases induces increases in consumer spending. An important number in this formula is the marginal propensity to consume (MPC)—the fraction of extra income that a household consumes rather than saves. For example, […]

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34-2b The Multiplier Effect

When the government buys $20 billion of goods from Boeing, that purchase has repercussions. The immediate impact of the higher demand from the government is to raise employment and profits at Boeing. Then, as the workers see higher earnings and the firm owners see higher profits, they respond to this increase in income by raising their […]

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34-2a Changes in Government Purchases

When policymakers change the money supply or the level of taxes, they shift the aggregate-demand curve indirectly by influencing the spending decisions of firms or households. By contrast, when the government alters its own purchases of goods and services, it shifts the aggregate-demand curve directly. Suppose, for instance, that the U.S. Department of Defense places […]

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34-2 How Fiscal Policy Influences Aggregate Demand

The government can influence the behavior of the economy not only with monetary policy but also with fiscal policy. Fiscal policy refers to the government’s Choices regarding the overall level of government purchases and taxes. Earlier in the book, we examined how fiscal policy influences saving, investment, and growth in the long run. In the […]

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Case Study: Why the Fed Watches the Stock Market (and Vice Versa)

“The stock market has predicted nine out of the past five recessions.” So quipped Paul Samuelson, the famed economist (and textbook author). Samuelson was surely right that the stock market is highly volatile and can give wrong signals about the economy. But fluctuations in stock prices are often a sign of broader economic developments. The […]

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