Transcript Chapter19_20_Fiscal Policy and Multiplier

Interactive Examples
Fiscal Policy and the Multiplier
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Material from this presentation can be found in:
Chapter 19
Chapter 20
Slides By
David Gillette and Kevin Brady
Interactive Examples
Fiscal Policy and the Multiplier
An economy is in long-run equilibrium when the
aggregate demand curve (AD), short-run aggregate
supply curve (SRAS), and long-run aggregate supply
curve (LRAS) intersect at the same price level and
output level.
Price
Level
(P)
LRAS
SRAS
Question 1:
Suppose consumers suddenly cut back on spending.
What happens in the economy?
Pe
AD
Qf
Aggregate
Output (Q)
Answer
Interactive Examples
Fiscal Policy and the Multiplier
Question 1:
Suppose consumers suddenly cut back on spending.
What happens in the economy?
Next
LRAS
Price
Level
(P)
Answer to Question 1:
SRAS
When consumers reduce spending, the AD curve
shifts down and to the left.
This results in a short-run equilibrium at a
lower output level (Q1) and a lower price level
(P1).
Pe
P1
AD
Q1
Qf
Aggregate
Output (Q)
Interactive Examples
Fiscal Policy and the Multiplier
Question 2:
Suppose a new discovery of raw materials lowers
input prices throughout the economy. What happens
in the economy?
Price
Level
(P)
LRAS
SRAS
Pe
AD
Qf
Aggregate
Output (Q)
Answer
Interactive Examples
Fiscal Policy and the Multiplier
Question 2:
Suppose a new discovery of raw materials lowers
input prices throughout the economy. What happens
in the economy?
Next
Price
Level
(P)
LRAS
SRAS
Answer to Question 2:
When input prices decline, the SRAS curve shifts
down and to the right.
This results in a short-run equilibrium at a
higher output level (Q1) and a lower price level
(P1).
Pe
P1
AD
Qf
Q1
Aggregate
Output (Q)
Interactive Examples
Fiscal Policy and the Multiplier
In the previous two examples, the economy started at
long-run equilibrium. Let’s examine a situation where
the economy is below its long-run equilibrium output
level, at Q1.
LRAS
Price
Level
(P)
Question 3:
The government realizes the economy is operating
below equilibrium and decides to implement a
stimulus package that includes spending on
infrastructure. What effect will this have on our
model?
SRAS
Pe
P1
AD
Q1
Qf
Aggregate
Output (Q)
Answer
Interactive Examples
Fiscal Policy and the Multiplier
In the previous two examples, the economy started at
long-run equilibrium. Let’s examine a situation where
the economy is below its long-run equilibrium output
level.
Next
LRAS
Price
Level
(P)
Question 3:
The government realizes the economy is operating
below equilibrium and decides to implement a
stimulus package that includes spending on
infrastructure. What effect will this have on our
model?
Answer to Question 3:
SRAS
Pe
P1
When the government spends, the AD curve
shifts up and to the right.
In this graph, the result is a return to the longrun equilibrium at Qf and Pe.
AD
Q1
Qf
Aggregate
Output (Q)
Interactive Examples
Fiscal Policy and the Multiplier
In the previous three examples, we looked at the
short-run implications of various shocks and
government policies. Let’s examine what happens in
the long run.
LRAS
Price
Level
(P)
The graph to the right shows our economy operating
below the long-run equilibrium. Let’s assume we are
$1 billion below equilibrium output at Q1, the
spending multiplier is 2, and Congress passes a $1
billion dollar stimulus package.
Question 4:
What would happen in our model?
SRAS
Pe
P1
AD
Q1
Qf
Aggregate
Output (Q)
Answer
Interactive Examples
Fiscal Policy and the Multiplier
In the previous three examples, we looked at the short-run
implications of various shocks and government policies. Let’s
examine what happens in the long-run.
The graph to the right shows our economy operating below the
long-run equilibrium. Let’s assume we are $1 billion below
equilibrium output at Q1, the spending multiplier is 2, and
Congress passes a $1 billion dollar stimulus package.
LRAS
Price
Level
(P)
Question 4:
SRAS
P3
What would happen in our model?
Answer to Question 4:
P2
Despite the government’s good intentions, they failed to
take into account the effect of the spending multiplier, and
so the AD curve shifts past the point where long-run
equilibrium would have been, all the way to Q2 and P2.
The higher level of output is only temporary, however, as
workers and suppliers adjust their expectations to the higher
price level of P2. This causes the SRAS curve to shift up and to
the left. Prices rise further until workers adjust their
inflationary expectations and a new long-run equilibrium is
reached at Qf and P3.
The End
Pe
P1
AD
Q1
Qf
Q2
Aggregate
Output (Q)