Fiscal Policy Government Intervention in the Free Market?
AD2 However, Wages did not adjust Classical Model Failure: The Great Depression Real GDP ↓ 27% Unemployment 3% → 25% Price Level fell Price Level LRAS1 AD1 Real GDP
John Keynes 1883-1946 • Argued Government intervention was necessary to moderate the “ups & downs” of business cycle • Recessions could be long or permanent • Dominated economics during Great Depression
AD AD 2 Types of Fiscal Policy • Expansionary Policy • Used in recessionary gap • Contractionary Policy • Used in inflationary gap Increase Gov’t Spending Decrease Taxes => Decrease Gov’t Spending Increase Taxes =>
LRAS1 Price Level SRAS1 Real GDP AD1 Fiscal Policy Introduction Worksheet
Recessionary Gap LRAS1 LRAS1 Price Level Price Level SRAS1 SRAS1 Real GDP Real GDP AD1 AD1 Inflationary Gap Economy above full output Economy below full output Contractionary Fiscal Policy Gov’t would raise income taxes => (C↓) Decrease Gov’t Spending (G↓ ) End result: AD shifts left, debt falls Expansionary Fiscal Policy Gov’t would lower income taxes => (C↑) Increase Gov’t Spending (G↑) End result: AD shifts right, debt rises