Chapter

Aggregate Demand and Fiscal policy

 Chapter objectives

1. Aggregate demand tổng cầu

2. Short-run effects of fiscal policy on aggregate

demand tác động ngắn hạn của chính sách tài khóa lên tổng cầu

3. Fiscal policy and Automatic stabilizers

chính sách tài khóa và cơ chế tự điều chỉnh

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1. Aggregate Demand (AD)
1.1 Definition of AD curve the relationship between Price and demand is negative

The price P
level
P2
Aggregate Demand
curve shows the
quantity of all goods
P1
and services (g&s)
demanded AD
in the economy at
any given price level. Y
Y2 Y1
if C increases -> consumption increases Quantity of output
tax increases -> Consumption decreases
đọc sách hmu

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1.2 The components of AD
• Aggregate demand is the sum of four
components: consumption, investment,
government spending, and net exports
AD= C + I + G + NX
– Consumption can change for a number of reasons, including movements in
income, and taxes.
– Investment can change in response to its expected profitability, interest rates, the
price of key inputs, and tax incentives for investment.
– Government spending and taxes are determined by political considerations.
– Net exports change according to exchange rates, trade policy of the importing
and exporting countries, and incomes of the nations
ad là lượng hàng hóa demanded -> change accroding to the change in the price
Meanwhile, gdp là lượng hàng hóa sản xuất - does not depend on the price
-> tại mỗi gtri P, có một GDP, còn AD changes corresponding to the price
+khi tính GDP ko tính import vào vì sẽ bị offset bởi các thành phần khác(C,I) vì nó đã trao đến tay người tiêu dùng ( tính cuối
kì); tính tại 1 thời điểm và một mức giá nhất định vì đã trao đến tay người tiêu dùng
Meanwhile, AD chỉ là hàng hóa demanded, chưa được đưa đến tay người tiêu dùng, chưa được bán nên giá thấp mua nhiều,
giá cao mua ít
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1.3 Why the AD Curve Slopes Downward

Assume G fixed P
by govt policy. (G constant)
To understand P2
the slope of AD,
must determine
how a change in P P1
affects C, I, and NX.
AD
Proof: When P increases lead to all component of
AD decrease
-> prove 3 negative relationships
Y
Y2 Y1

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a. The Wealth Effect (P and C ) hiệu ứng của cải

Suppose P rises. Bài thi có chứng minh chiều P giảm:

• The dollars people hold buy fewer g&s,

so the dollars decrease in value.
• People feel poorer.
Result: C falls.
Suppose P decreases

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b. The Interest-Rate Effect (P and I )
Suppose P rises. interest rate reflects the cost of investment and its return - phần tiền lời

goodd and services

• Buying g&s requires more dollars.

• To get these dollars, people sell bonds or
other interest-bearing assets.
• This drives up interest rates.
Result: I falls.
Interest rate is paid for financial assets - tài sản tài chính

When prices level increases, to hold more money company had to sold the financial assets, to sold the financial, company
have to make the financial assets become more attractive, increase the interest

When prices level decreases, company have more money to buy financial assets, the sellers decreases the interest rate for
the buyers, when interest rate decline also means that the investment increases (the cost of the investment - declines)

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c. The Exchange-Rate Effect (P and NX )
Suppose P rises.
• U.S. interest rates rise (the interest-rate effect).
• Foreign investors desire more U.S. bonds.
• Higher demand for $ in foreign exchange
market.
• U.S. dollar appreciates.
• U.S. exports more expensive to people abroad,
imports cheaper to U.S. residents.
Result: NX falls.
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 The Slope of the AD Curve: Summary
An increase in P P Khi đi thi giữa kì chắc chắn hỏi về 1 trong 3 hiệu ứng nhưng
theo chiều ngược lại
reduces the quantity
of g&s demanded
P2
because:
▪ the wealth effect
(C falls)
P1
▪ the interest-rate
AD
effect (I falls)
▪ the exchange-rate Y
Y2 Y1
effect (NX falls)

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1.4 Why the AD Curve Might Shift
nhớ ôn theo chiều ngược lại của slides
Any event that changes C,
I, G, or NX P
– except a change in P –
will shift the AD curve.
assume that other factors remained unchanged

Example: P1
A stock market boom
makes households feel …. C
….,
richer, consumption increases which leads
AD2
AD1
the AD curve shifts … to the right

change in pirce lead to a movement in AD curve Y1 Y2 Y

So what factors might lead the AD curve shift leftward or rightward?
C,I,G, NX - consumption

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 Question
Explain whether each of the following events
will have effects on aggregate demand.
a. Households decides to save a larger share of
their income consumption decreases - leftward

b. An increase in the price level interest rate increases - investment

decreases - move leftward

c. Expectations of a growing economy lift

business confidence and investment
investment increases - rightward

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2. Fiscal Policy and Aggregate Demand
2.1 Fiscal policy chính sách tài khóa

The setting of the level of government

purchases and taxes by government
policymakers.
– Expansionary fiscal policy
government spending
• an increase in G and/or decrease in T T:trong
• shifts AD curve to the right
chính sách tài khóa mở rộng- đường cầu dịch phải
personal income tax;
sách mankiw rộng hơn, include
personal income tax + corporate income
tax ( đánh vào doanh nghiệp) - investment
giảm

– Contractionary fiscal policy chính sách tài khóa thắt chặt- lead AD curve shift to the
left - output demanded decreases

• a decrease in G and/or increase in T -> affect consumption and investment

(decrease)
• shifts AD curve to the left

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2.2 Effects of fiscal policy on aggregate demand

a. The Multiplier Effect Tác động số nhân giảm T là bài tập về nhà

• If the govt buys $20b of planes from Boeing, Boeing’s

revenue increases by $20b.
• This is distributed to Boeing’s workers (as wages) and
owners (as profits).
• These people are also consumers and will spend a portion
of the extra income.
• This extra consumption causes further increases in
aggregate demand. (the process goes on and on
C consumption continues to increases which leads the AD continues to increase

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 a. The Multiplier Effect

A $20b increase in G P
initially shifts AD
to the right by $20b.
AD2 AD3
The increase in Y AD1
causes C to rise, which
shifts AD further to the P1
right.
$20 billion

Y1 Y2 Y3 Y
Multiplier effect: the additional shifts in aggregate demand
that result when expansionary fiscal policy increases
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income and thereby increases consumer spending
a. The Multiplier Effect
• How big is the multiplier effect?
It depends on how much consumers respond to
increases in income.
xu hướng tiêu dùng cận biên

• Marginal propensity to consume (MPC):

the fraction of extra income that households
consume rather than save MPC= delta C/ Delta Y

delta C=0.75 * delta Y

E.g., if MPC =0.75, this means… when income increases by 1$, the consumption
increases by 0.75$

When workers and owners of Boeing earn $20b,

they increase their consumer spending by… 0.75*$20b=$15b

*0.25$ is spent for saving or saving increases by 0.25$

0<MPC<1
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a. The Multiplier Effect
Notation: G is the change in G,
Y and C are the ultimate changes in Y and C
Y = C + I + G + NX identity
Y = C + G I and NX do not change

Y = MPC Y + G because C = MPC Y

Y =
1
G solved for Y
1 – MPC

The multiplier

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a. The Multiplier Effect
The size of the multiplier depends on MPC.
E.g., if MPC = 0.5 multiplier =
if MPC = 0.75 multiplier =
if MPC = 0.9 multiplier =

A bigger MPC means

1 changes in Y cause …
Y = G
1 – MPC changes in C, which in
turn cause
The multiplier … changes in Y.

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b. The Crowding-Out Effect
• Fiscal policy has another effect on AD
that works in the opposite direction.
• A fiscal expansion raises r,
which reduces investment,
which reduces the net increase in agg demand.
• So, the size of the AD shift may be smaller than
the initial fiscal expansion.
• crowding-out effect: The reduction in
aggregate demand that results when a fiscal
expansion raises the interest rate
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b. The Crowding-Out Effect
A $20b increase in G initially shifts AD right by $...b
P

AD AD2
AD1 3

P1
$20 billion

Y1 Y3 Y2 Y

But higher G leads to higher r, which reduces AD.

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 Question
• How can a tax change affect aggregate
demand ?

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ACTIVE LEARNING
Discussion
Should policymakers use fiscal policy to control
aggregate demand and stabilize the economy? If
so, when? If not, why not?

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3. Fiscal policy and Automatic stabilizers
3.1 The Case For Active Stabilization Policy
người đề xuất/ người ủng hộ

• Proponents of active stabilization policy

believe the govt should use policy to reduce
economic fluctuations:
– use an expansionary policy to prevent or reduce a
recession.
– use a contractionary policy to prevent or reduce an
expansion.

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3. Fiscal policy and Automatic stabilizers
3.2 The Case Against Active Stabilization Policy
• Fiscal policy works with a long lag:
– Changes in G and T require Acts of Congress.
– The process can take months or years.
• Due to the long lags, critics of active policy argue that
such policies may destabilize the economy rather than
help it: By the time the policies affect agg demand,
the economy’s condition may have changed

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3.3 Automatic Stabilizers
• Automatic stabilizers
changes in fiscal policy that stimulate agg
demand when economy goes into recession,
without policymakers having to take any
deliberate action

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3.3 Automatic Stabilizers: Examples
• The tax system
– In recession, taxes fall automatically.

• Transfer payment
– In recession, more people apply for public
assistance (welfare, unemployment insurance).

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ACTIVE LEARNING
Exercise
The economy is in recession.
Shifting the AD curve rightward by $200b
would end the recession.
A. If MPC =0.8 and there is no crowding out,
how much should Congress increase G
to end the recession?
B. If there is crowding out, will Congress need to
increase G more or less than this amount?

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 CHAPTER SUMMARY

• An increase in P reduces the quantity of g&s

demanded because of wealth effect, interest rate
effect and exchange rate effect.
• Expansionary fiscal policy – a spending increase
or tax cut – shifts aggregate demand to the right.
Contractionary fiscal policy shifts aggregate
demand to the left.

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CHAPTER SUMMARY

• When the government alters spending or

taxes, the resulting shift in aggregate demand
can be larger or smaller than the fiscal
change:
phóng đại

– The multiplier effect tends to amplify the effects

of fiscal policy on aggregate demand.
– The crowding-out effect tends to dampen the
effects of fiscal policy on aggregate demand.
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 CHAPTER SUMMARY

• Economists disagree about how actively policymakers

should try to stabilize the economy.
• Some argue that the government should use
fiscal policy to combat destabilizing fluctuations in
output and employment.
• Others argue that policy will end up destabilizing the
economy because fiscal policy works with long lags.

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