Current Events:
Supply Side Economics: The Case of India
The Test for Tuesday on Chapter 17 is a combination of question types such as Multiple Choice and Short Answer. Refer to the Chapter 17 Test Prep Page for details.
We will pick up where we left off in Chapter 20.
Chapter 20 Fiscal Policy
Chapter Overview
The topic of fiscal policy is addressed in three major units: demand-side fiscal policy, supply-side fiscal policy, and the implementation of fiscal policy. The third section (on implementation) includes coverage of automatic stabilizers, lags, and the crowding out effect. The chapter also includes a section that considers the debate over the size of government.
Fiscal Policy, 4:34
Chapter Outline
Fiscal Policy and Aggregate Demand
Discretionary Fiscal Policy
Government Spending
Taxes
Transfers
Expansionary and Contractionary Fiscal Policy
Expansionary and Contractionary Fiscal Policy, 3:22
Checkpoint: Fiscal Policy and Aggregate Demand
Fiscal Policy and Aggregate Supply
Modern Growth Theory
Reducing Tax Rates
Understanding Supply Side Economics, 1:08
The Laffer Curve, 7:40
The Laffer Curve charts a relationship between tax rates and tax revenue. While the theory behind the Laffer Curve is widely accepted, the concept has become very controversial because politicians on both sides of the debate exaggerate. This video shows the middle ground between those who claim "all tax cuts pay for themselves" and those who claim tax policy has no impact on economic performance. This video, focusing on the theory of the Laffer Curve, is Part I of a three-part series. Part II reviews evidence of Laffer-Curve responses. Part III discusses how the revenue-estimating process in Washington can be improved. For more information please visit the Center for Freedom and Prosperity's web site: www.freedomandprosperity.org
High Marginal Income Tax Rates and the Labor Supply of Women
Average vs. Marginal Tax Rates, 5:18
Expanding Investment and Reducing Regulations
Checkpoint: Fiscal Policy and Aggregate Supply
Implementing Fiscal Policy
Automatic Stabilizers
Fiscal policy & automatic stabilizers, 8:24
Fiscal Policy Timing Lags
Crowding-Out Effect
Crowding Out & Lags, 5:52
The Size of Government Debate
Checkpoint: Implementing Fiscal Policy
Ideas for Capturing Your Classroom Audience
Celebrate tax freedom day! Never heard of it? According to The Tax Foundation,
it is the number of days in a year Americans work to pay for government. In 2007
it fell on April 30, four days later than in 2006. See the Web site at http://www.
taxfoundation.org/taxfreedomday/ and relate this to the debate over the size of
government.
Where's the pork? Visit the Web site of Citizens Against Government Waste at
http://www.cagw.org/site/PageServer?pagename=reports_pigbook2007. This self described taxpayer watchdog organization has developed criteria by which to
identify wasteful projects. Relate this to the text material about politics and government spending.
Chapter Checkpoints
Demand-Side Fiscal Policy
Question: Explain why cutting taxes represents expansionary fiscal policy.
The point is to check that students can: apply their knowledge of the determinants
of aggregate demand to help evaluate the effect of cutting taxes (the key link is less taxes to more income to more spending).
Supply-Side Fiscal Policy
Question: In 1962 at a speech before the Economic Club of New York, President
John F. Kennedy argued that "it is a paradoxical truth that taxes are too high
today and tax revenues are too low.and the soundest way to raise taxes in the long
run is to cut rates now. Is President Kennedy's argument consistent with supply side economics? Why or why not?
The point is to check that students can: apply their comprehension of the material
on supply-side economics and evaluate the quote from President Kennedy.
Implementing Fiscal Policy
Question: Unless the economy enters a deep recession, we rarely hear Congress
discuss the budget in terms of fiscal policy: passing a spending and taxing package for macroeconomic purposes. Most of the discussion is on particular spending priorities for specific programs and bringing home projects for an individual politician's district. Has Congress essentially abandoned fiscal policy and left macroeconomic stabilization to the Federal Reserve and the setting of monetary policy?
The point is to check that students can: understand how changes in the price of oil affect the economy. It might be useful to point out that the initial effect is a decrease in aggregate supply against an unchanging aggregate demand.
Extended Example in the Chapter
The Size of Government Debate
Fiscal policy debates may have as much (if not more) to do with the philosophical
debate about the proper size of government as about the state of the macroeconomy.
In general, those on the left of the political spectrum favor a larger and more
active government while those on the right are constantly looking for ways to limit the size and power of the government. Examining federal receipts and expenditures as a percentage of GDP reveals the federal government’s tendency to spend more and more. The reason for this seems obvious: to cut spending Congress must cut programs, and whose programs would be cut? (In a later chapter, Chapter 23, the question of the budget deficit will be considered in more detail.)
Examples Used in the End-of-Chapter Questions
Question 2 references an article by Robert Dunn, titled “Let the Surplus Go” (The
New York Times, August 19, 2001) regarding the declining budget surplus. A summary
of the article in outline form (with key words noted) appears on the Web site
of Truth and Politics at http://www.truthandpolitics.org/html_gen.php?entryId=55.
Question 4 references The Power of Productivity by William Lewis (Chicago:
University of Chicago Press, 2004). An interview with William Lewis (by Nick
Schultz) is available on the Web site of TCS Daily: Technology, Commerce, Society,
at http://www.techcentralstation.com/061705A.html. Among the points elaborated
in the interview are Lewis’s views about the combination of big government and
underdeveloped economies.
The pieces are “Remember Fiscal Policy?” in the “Economics Focus” section and
“The Case for Using Fiscal Policy” in the “Economic Policy Section.” The first piece presents the arguments that fiscal policy may have less of an effect on the economy than its proponents contend and moreover, that for political reasons, policymakers are “incapable of designing the right measures or enacting them at the right time.” The second piece contends that Keynesian measures to counteract a recession (particularly deficit spending) went “out of fashion years ago.” It goes on to suggest that such methods had been misapplied, meaning that they were being used to promote growth as opposed to counteracting recession.
For Further Analysis
Using the AS/AD Model to Explore the Impacts of Demand-Side Fiscal Policy
This example can be used as an in-class small group exercise or as an individual in class exercise. It is designed to complement the text’s material by employing the graphical analysis of the AS/AD model to illustrate the effects of demand-side fiscal policy when the economy is below full employment and when it is above full employment. It would not be difficult to adapt the handout to have students consider contractionary policy as well.
Note that for the second question students will have to show a shift in aggregate
demand and then a resulting shift in aggregate supply in order for the economy to
return to long-run equilibrium. You may also wish to summarize the assignment,
pointing out how important it is for the government to assess how close GDP is to
full employment and that regardless of the current level of output (compared to Qf), expansionary fiscal policy seems to always result in higher prices.
Web-Based Exercise
Listen to the Candidates Debate
This example can be used as a small group exercise or as an individual exercise.
The exercise provides an opportunity for students to apply the material in the chapter to positions of political candidates. This also allows students to appreciate the political spectrum, particularly in terms of the “middle” where positions are not so clearly “left” or “right.” You can make the assignment more or less extensive by choosing a number of candidates for students to consider, including local or state candidates as well as presidential and congressional candidates. Alternatively, you can also have students learn more about the positions of their already-elected state (or local) representatives; for example, what are their voting records?
Listen to the Candidates Debate
Visit the Web sites of political candidates and learn more about their positions with regard to the economy, particularly in terms of taxes and spending. Remember that government spending is associated with funding particular programs.
Tips from a Colleague
Students may not appreciate that the size of government is an ongoing matter of
debate in the United States and other countries. You may wish to review the material from Chapter 1 regarding the role of government in the economy and discuss the normative aspects of economics. Students may not fully appreciate the role of Congress and the interaction between Congress and the Executive Branch in terms of fiscal policy, so the process may be worth a brief review, particularly in the discussion of lags.
References
This video is based on the book Economics by McConnell and Brue.
Sarah Zubairy, a Ph.D. job market candidate in economics at Duke University, talks about her research on fiscal multipliers and a micro-founded medium-scale dynamic stochastic general equilibrium (DSGE) model developed and estimated to explain the effects of discretionary fiscal policy.
The Laffer Curve: Past, Present, and Future by Arthur B. Laffer
The Laffer Curve charts a relationship between tax rates and tax revenue. While the theory behind the Laffer Curve is widely accepted, the concept has become very controversial because politicians on both sides of the debate exaggerate. This video shows the middle ground between those who claim "all tax cuts pay for themselves" and those who claim tax policy has no impact on economic performance. This video, focusing on the theory of the Laffer Curve, is Part I of a three-part series. Part II reviews evidence of Laffer-Curve responses. Part III discusses how the revenue-estimating process in Washington can be improved. For more information please visit the Center for Freedom and Prosperity's web site: www.freedomandprosperity.org
The Napkin Sketch That Introduced Supply-Side Economics, 2:50
Dan Roam, author of The Back of the Napkin, discusses how a simple graph drawn on the back of a napkin -- later to be known as the "Laffer Curve" -- became "the basis of supply-side economics" for the late 20th century.
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Dan Roam urges us to think with our eyes and tackle tough business problems in a whole new way - even if we draw like a second-grader.
He introduces powerful techniques from his "visual thinking" toolbox and demonstrates how people in diverse organizational settings can discover, develop and share their best ideas with a simple drawing on a basic napkin. - The Commonwealth Club of California
Dan Roam is the founder and president of Digital Roam Inc., a consulting firm that helps clients solve complex problems through visual thinking. He's also the author of The Back of the Napkin: Solving Problems and Selling Ideas with Pictures.
1. Be sure to review the Chapter 17 Test Prep Page for details about the Test on Tuesday.
2. Review Chapters 18-19 (we will have Quizzes and Tests on this material as well, TBA).
3. Ch. 20, this material, in contrast to the older material, is new and you should answer in writing as part of your HW:
Questions and Problems, p. 542-43, #9-15.
4. As review for HW, a typical question that you may encounter on the actual AP Economics Macro Test is included daily:
#5.
If the demand for plums increases and the supply of plums decreases, which of hte following is true?
a) The price and the quantity will both increase.
b) The price will increase, bu the quantity will decrease.
c) The price will rise, but it will be impossible to determine the change in the quantity.
d) The price will fall, but it will be impossible to determine the change in the quantity.
e) The quantity will rise, but it will be impossible to determine the change in the price.
