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ECON102: Principles of Macroeconomics

Unit 5: Government and Fiscal Policy   What effect does a government have on an economy?  Through its ability to tax, a government takes away a proportion of its people’s income, but it also injects money into the economy by printing currency and purchasing public goods.  What are the consequences of these actions?  Clearly, government spending and taxing will have an effect on the equilibrium GDP, but by what magnitude?  How do those policies affect inflation, unemployment, and economic growth?  Macroeconomics studies these and other questions pertaining to the relationship between a government and an economy.  In doing so, it often uses the concept of the multiplier, which, as you learned in the previous unit, refers to the relationship between a change in spending and the impact that change has on the entire economy.  In this unit, we will explore these issues and examine other government policies, such as budgets, debts, and deficits, discussing their respective effects on the economy as a whole.

Unit 5 Time Advisory
This unit should take approximately 5 hours to complete.

☐    Subunit 5.1: 0.5 hours

☐    Subunit 5.2: 1 hour

☐    Subunit 5.3: 1.5 hours

☐    Assessments: 2 hours

Unit5 Learning Outcomes
Upon successful completion of this unit, the student will be able to: - Demonstrate an understanding of the major components of U.S. government spending and sources of government revenues. - Define the terms budget surplus, budget deficit, balanced budget, and national debt, and discuss their trends over time in the United States. - Compute Government Spending Multiplier, the Tax Multiplier, and the Balanced Budget Multiplier. - Define automatic stabilizers and explain how they work. - Explain and graphically illustrate how discretionary fiscal policy works and compare the changes in aggregate demand that result from changes in government purchases, income taxes, and transfer payments. - Explain how the various kinds of lags influence the effectiveness of discretionary fiscal policy. - Explain and graphically illustrate how crowding out (and its reverse) influence the impact of expansionary or contractionary fiscal policy. - Discuss the controversy concerning which types of fiscal policies to use, including the arguments from supply-side economics.

5.1 Government in the Economy   - Reading: Principles of Macroeconomics: “Chapter 12, Section 1: Government and the Economy” Link: Principles of Macroeconomics: “Chapter 12, Section 1: Government and the Economy” (PDF)

 Instructions: This material elaborates on the major components of
government spending and the sources of government revenue.  You will
also about the terms budget surplus, budget deficit, balanced
budget, and national debt.  Read the section in its entirety,
including the introduction, noting trends in the U.S. government’s
budget over time.  Lastly, try to answer the questions in the “Try
It” box at the end of each section before reviewing the solutions
that follow.  

 Terms of Use: This text was adapted by The Saylor Foundation under
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attribution as requested by the work’s original creator or licensee.

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5.2 Fiscal Policy   - Reading: PEOI.org: John Petroff’s Macroeconomics: “Chapter 9: Fiscal Policy”

Link: PEOI.org: John Petroff’s *Macroeconomics*: [“Chapter 9: Fiscal
Policy”](http://www.saylor.org/site/wp-content/uploads/2012/06/Chapter-9-Fiscal-Policy-Petroff.pdf) (PDF)  

 Instructions: On the right side of the navigation bar, click on
“Chapter 9: Fiscal Policy.”  This chapter discusses the concepts
associated with fiscal policy, and contains an answer key to assess
understanding of the material.  Note that this material also covers
the topics outlined in subunits 5.2.1-5.2.3.


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Commons Attribution-NonCommercial-Share-Alike
License](http://creativecommons.org/licenses/by-nc-sa/2.5/deed.en). 
You can find the original version of this
article [here](http://www.peoi.org/Courses/Coursestu/mac/fram9.html).

5.2.1 Government Spending Multiplier   Note: The government spending multiplier is a tool used to manipulate the economy and mitigate inflation or recession that goes beyond the ordinary uses of taxes.  In this process, the government spending multiplier deploys additional monies or restricts monies to assist in economic stability.

5.2.2 Tax Multiplier   Note: The tax multiplier is a tool used to manipulate the economy and mitigate inflation or recession that goes beyond the ordinary uses of taxes.  In this process, the tax multiplier uses the manipulation of taxes, which is known as fiscal policy.

5.2.3 Balanced Budget Multiplier   Note: The balanced budget multiplier operates within the context of aggressively reducing a deficit by collecting more taxes to enable the government’s revenue to match its expenses.

5.3 Stabilizing the Business Cycle   - Reading: University of Washington: Professor Colin Danby’s Macroeconomics Teaching Notes: “Aggregate Demand” Link: University of Washington: Professor Colin Danby’s Macroeconomics Teaching Notes: “Aggregate Demand” (HTML)

 Instructions: This material covers subunits 5.3.1-5.3.3.  Scroll
through these lecture notes to section 1.12, “Counter Cyclical and
Pro-cyclical Policies,” and read all the way up to section 1.15,
“Further Notes.”  The government’s fiscal actions can stabilize the
business cycle by changing aggregate demand.  This can be done
either by an act of Congress requiring a change in a spending
program or in a tax law (which are both examples of discretionary
fiscal policy), or it can be triggered by the state of the economy
(which is known as automatic fiscal policy).  The readings in this
subunit will elaborate on the mechanisms of both kinds of policies
and will also touch upon the problems that arise when managing
fiscal policy.  The following resources will elaborate on the
concepts that are presented in this material.  

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  • Reading: Principles of Macroeconomics: “Chapter 12, Section 2: The Use of Fiscal Policy to Stabilize the Economy” Link: Principles of Macroeconomics: “Chapter 12, Section 2: The Use of Fiscal Policy to Stabilize the Economy” (PDF)

    Instructions: This material will cover subunits 5.3.1 and 5.3.2.  Read all of section 2 to learn about how the government’s fiscal actions influence aggregate demand.  This section first discusses automatic stabilizers and how they function.  The chapter then covers discretionary fiscal policy, which are changes in aggregate demand resulting from changes in government purchases, income taxes, and transfer payments.

    Terms of Use: This text was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-Share-Alike 3.0 License without attribution as requested by the work’s original creator or licensee.

5.3.1 Automatic Stabilizers   Note: Automatic stabilizers are the non-discretionary occurrences that mitigate fluctuations in GDP.  When that happens, the government non-discretionally receives taxes or revenue from its citizenry rather than making a discretionary decision.  This topic was briefly introduced in Paj Holden’s YouTube video listed under 1.3.1.

5.3.2 Discretionary Fiscal Policy   Note: Discretionary fiscal policy is how the executive and legislative branches exercise their choice of increasing or decreasing taxes to attain economic stability.

5.3.3 Fiscal Policy Concerns   - Reading: Principles of Macroeconomics: “Chapter 12, Section 3: Issues in Fiscal Policy”

Link: *Principles of Macroeconomics*: [“Chapter 12, Section 3:
Issues in Fiscal
Policy”](http://www.saylor.org/site/textbooks/Principles%20of%20Macroeconomics.pdf) (PDF)  

 Instructions: Read all of this section, which will outline the
problems that can arise in fiscal policy.  This section will also
provide you with a brief look at the debate surrounding supply-side
economics.  

 Terms of Use: This text was adapted by The Saylor Foundation under
a [Creative Commons Attribution-NonCommercial-Share-Alike 3.0
License](http://creativecommons.org/licenses/by-nc-sa/3.0/) without
attribution as requested by the work’s original creator or licensee.

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Unit 5 Assessment   - Assessment: Econ100’s “Chapter 13: Fiscal Policy Quiz”

Link: Econ100’s [“Chaper 13: Fiscal Policy
Quiz”](http://www.econ100.com/usa/mac5e/index.html) (HTML)  

 Instructions: Click on the “Quiz” tab on the left-hand menu and
then go to “Chapter 13” to take the quiz.


 Terms of Use: Please respect the copyright and terms of use
displayed on the webpage above.
  • Assessment: Cengage Learning: William Boyes and Michael Melvin’s Economics: “Chapter 12: Fiscal Policy, Test 1 and Test 2”

    Link: Cengage Learning: William Boyes Michael Melvin’s Economics: “Chapter 12: Fiscal Policy, Test 1 and Test 2” (Flash)

    Instructions: Click on the links for “Test 1” and “Test 2” beneath “Chapter 12”on the linked page, and complete each assessment.  Once you have selected an answer choice, a note at the bottom of the screen will indicate whether or not your choice was correct.

    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.