3.

8 NOTES
Essential Question: how do government fiscal policies involving spending and taxation affect
demand, GDP, and employment?

Government Fiscal Policies

Fiscal Policy refers to changes in spending and taxes made by the government to affect overall
spending
These policies were greatly influenced by British economist John Maynard Keynes
Believed governments could help stabilize an economy by implementing fiscal policies
Based primarily on spending and taxation that reduce dramatic ups and downs
Some policies are ways government handles complicated needs and services
Nation defense and social insurance
Others are meant to be a stimulus to the economy

Taxation and Expenditures

Governments collect taxes to pay for goods and services citizens want
About half of government revenue goes directly to state and local governments
Other half of government revenue goes to the federal government
- personal income taxes
- corporate profit taxes
- social insurance fees for programs such as social security, medicare and medicaid

Mandatory spending/transfers are programs that must be paid for with no goods or services in
return
Discretionary spending results from legislation or policies that are not mandatory

Fiscal Policy as Stimulus

Changes in government spending have a direct effect on aggregate demand and purchasing
Always a lag associated with discretionary stimulus spending by government

Multiplier Effect and Fiscal Stimulus Policy

Fiscal spending and transfer policies are so effective because of the multiplier effect
When governments spend money on goods and services, a chain reaction throughout the
economy is created
Depending on MPC and MPS, every dollar of stimulus will lead to a certain amount of additional
spending

Multiplier Effect and Taxes and Transfers

A transfer payment is money transferred to citizens with no good or service in return
Examples include social security, Medicare, and medicaid
When governments make changes in taxes or transfer payments, the multiplier effect still
applies
The tax/transfer multiplier’s impact on GDP and AD curve is much less than the spending
multiplier
Expansionary and Contractionary Fiscal Policy
Two of the main purposes behind government fiscal policies are to combat recessions and
inflation

3.9 NOTES
Automatic stabilizers are fiscal policies that moderate economic fluctuations without special
government action
Progressive income tax structure is an important automatic stabilizer
Unemployment insurance provides support to individuals who have lost their jobs and helps
maintain spending during economic downturns
Supplemental Nutrition Assistance Program (SNAP) and Medicaid provide critical support to
those in need and help maintain spending during economic downturns
Government transfers are payments made by the government to individuals with no goods or
services provided in return
Automatic stabilizers play a crucial role in promoting stability and growth in the economy.

157 FRQ
1a - Recessionary gap
1b - Expansionary, decrease taxes or increase spending
1c - 1/0.2 = 5 60 / 5 = 12 billion increase
1d - Unemployment should drop as the gap closes because there is more things being
produced (gdp)

1e -

167 FRQ
1a -
1b - 1/.25 = 4 120 / 4 = 30 billion dollars. They would need to decrease taxes by more than they
would increase spending, because it doesn’t immediately become someone else's income.
1c - SRAS will eventually increase, as more unemployment leads to cheaper wages.

1d -

1e - LRAS will stay the same, because while this will lead to a larger labor market, bringing
production costs down, in the long run it will not matter.

5.1 NOTES
Fiscal policy refers to changes in government spending and taxes that impact economic activity
Major sources of government revenue include personal income taxes, corporate profit taxes,
and social insurance fees
Expansionary fiscal policy is used to stimulate growth through increased spending or tax cuts
Contractionary fiscal policy aims to reduce inflation through decreased spending or increased
taxes
Fiscal policy plays a critical role in shaping the economy.