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The Answer To: Define fiscal policy and identify the ways in which government can influence the economy.

Dear OTA: Problems with understanding macroeconomics. Could you please help with the following? Thank you so much. It is truly appreciated!

****Please define fiscal policy and identify the ways in which government can influence the economy.

****Please tell me the differences between fixed and variable taxes and provide examples of each.

****Suppose that the government decreases spending by $100 billion. What happens to aggregate demand? What is the likely effect on prices and output? Where are the new equilibrium price level and GDP relative to the old levels? Could you give me a graph???? If not that's okay. The graph helps me visualize the problem.

****Suppose the government decreases taxes by 20 percent. Describe the effects to the equilibrium price level and GDP. Please address consumption, disposable income, and aggregate demand in your answer.

****Suppose the government decreases spending by $20 billion. How much will this change equilibrium GDP if the MPC is 80 percent and the tax rate is 1/6 (16.6 percent)? Could you do a graph for this as well?

Solution Preview

****Please define fiscal policy and identify the ways in which government can influence the economy.
Fiscal policy: Use of the government's powers of spending and taxation to stabilize the business cycle.
The aggregate output is usually measured by GDP:
By Expenditure approach, we compute GDP that measures the amount spent on all final goods during a given period.
GDP = C + I + G + (EX - IM) (1)
Also, by the Leakages/Injections Approach to Equilibrium, we can derive:
GDP = Y = C + S + T (2)
It is the government's goal to adjust the GDP through the factors that it can control. From equation (1) and (2) we find that the government can only control two factors: Government Spending (G) and Taxation (T). Thus the government's usage of these two factors are called fiscal policy.
The fiscal policy is usually implemented in a counter-cyclical manner. When the economy is in a recession, GDP is low and inflation is high (or also low). Then the government should try to increase GDP by expansionary policies. It will increase government spending (in equation 1), which will increase GDP directly and also indirectly through multiplier effect.
Also government could reduce taxes to increase GDP through ...

Solution Summary

This solution outlines and defines fiscal policy in 836 words with step-by-step calculations for hypothetical situations to show, by example, the effects of certain changes.

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