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Unit 12. Aggregate supply and aggregate demand. Fiscal policies.

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Unit 12. Aggregate supply and aggregate demand. Fiscal policies. IES Llu s de Requesens (Molins de Rei) Batxillerat Social Economics (CLIL) Innovaci en ... – PowerPoint PPT presentation

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Title: Unit 12. Aggregate supply and aggregate demand. Fiscal policies.


1
Unit 12. Aggregate supply and aggregate demand.
Fiscal policies.
  • IES Lluís de Requesens (Molins de Rei)?
  • Batxillerat Social
  • Economics (CLIL) Innovació en Llengües
    Estrangeres
  • Jordi Franch Parella

2
  • The model of aggregate supply and demand is used
    to explain short-run fluctuations in economic
    activity
  • The aggregate demand shows the quantity of goods
    and services that households, firms and
    government want to buy at each price level
  • The aggregate supply shows the quantity of goods
    and services that firms want to produce and sell
    at each price level

3
Aggregate supply and demand
4
Aggregate demand
  • The aggregate demand has a negative slope,
    because of
  • Price level and consumption (the wealth effect)
    consumers feel wealthier and spend more
  • Price level and investment (the interest rate
    effect) a lower interest rate encourages greater
    spending
  • Price level and net exports (the exchange-rate
    effect) the real exchange rate depreciates,
    which stimulates net exports

5
Aggregate supply
  • In the short term, the aggregate supply is upward
    sloping (a lower price level makes production
    less profitable because nominal wages are fix)?
  • In the long run, the aggregate supply is vertical
    at the potential output or full-employment output
    (it depends on natural resources, labour,
    capital, entrepreneurship and technology)?

6
Expanding Aggregate Demand
7
Fiscal Policy
  • Fiscal policy refers to the choices of government
    spending and taxes by the state
  • Fiscal policy, in the short run, affects the
    aggregate demand
  • Fiscal policy, in the long run, affects saving,
    investment and growth

8
More government spending
  • When the government increases government
    spending, it expands public consumption and
    investment, it tries to expand aggregate demand,
    as well as production, employment and inflation
  • BUT it causes the crowding-out effect (it raises
    the interest rate, decreases the private
    investment and that offsets the initial increase
    in aggregate demand)?

9
Less taxes
  • When the government cuts income taxes, it
    increases households' disposable income
  • Households spend some of this additional income
    on consumer goods
  • Households save some of this additional income

10
More and less money ...
  • With an increase in the money supply (without a
    change in the money demand) the interest rate
    falls --gt it increases the aggregate demand at a
    given price level
  • With a decrease in the money supply the interest
    rate increases --gt it decreases the aggregate
    demand at a given price level

11
Active Fiscal Policy
  • Active stabilization. It involves the use of
    fiscal and monetary policies to pursue certain
    goals (to achieve full employment by means of
    fiscal deficits and creation of money out of thin
    air).
  • BUT it can destabilize the economy
  • Time lags and information problems
  • Crowding out of the private sector
  • Consumption not sensitive to tax changes
  • Government intervention increases aggregate
    demand too much or too little

12
Automatic Stabilizers
  • Automatic stabilizers are changes in fiscal
    policy that stimulate aggregate demand when the
    economy goes into a recession or dampen aggregate
    demand when the economy goes into a boom (without
    taking any deliberate action)?
  • Examples some forms of government spending
    (unemployment subsidies) and the tax system

13
Expansion and Contraction
  • Reflationary fiscal policies (more government
    spending and less taxes) and monetary policies
    (creation of money and lower interest rates) try
    to increase aggregate demand
  • Deflationary fiscal policies (less government
    spending and more taxes) and monetary policies
    (reduction of money and higher interest rates)
    try to decrease aggregate demand

14
Inflation and Unemployment
  • When the government expands aggregate demand, it
    can lower unemployment at the cost of higher
    inflation
  • When the government contracts aggregate demand,
    it can lower inflation at the cost of higher
    unemployment
  • This trade-off between inflation and unemployment
    (Phillips curve) is only supportable in the short
    run, but not in the long run (Phillips curve is
    vertical at the natural rate of unemployment)?
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