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APMacro: AD AS Fiscal Policy

Fiscal Policy
Fiscal policy consists of deliberate changes in government spending, taxes, or some combination of both to promote full employment, price level stability and economic growth. How does a change in government spending (G) or taxes (T) result in a change in output or national income (Y)? Multipliers express the ration of a change in aggregate output to a change in tan or spending policy, and fiscal policy works through the spending multiplier.

Suppose that the government decides to increase spending. An increase in G means that AD goes up by the same amount; firms increase production by the same amount to satisfy this increase in demand.Y increases by the same amount that G increases. An increase in production also means this new output gets sold and generates income for the producers. They in turn spend this income (investments) and consumption increases. As a result, demand increases again and so does production. This process keeps repeating until the final increase in output is much greater than the initial increase in G. How much greater depends on the spending multiplier. It describes increases and decreases in the effectiveness of fiscal policy.

The spending multiplier helps us to determine how a change in G will affect GDP. It is described by the following equation:

Government spending multiplier = 1 / (1 – MPC)
Real GDP = change in G x spending multiplier

MPC means marginal propensity to consume. MPC describes the proportion of each additional dollar of increase that will go toward consumption expenditures. MPS, the marginal propensity to save reveals the proportion of the additional dollar that is saved. MPC plus MPS is equal to 1. When MPC is high (close to a), this represents a high level of consumption; similarly the closer MPSis to 1, the higher the proportion of savings.

Information to evaluate the effect of a change in government spending: find the change in real GDP demanded if the MPC = 0.8

spending multiplier = 1 / (1 – MPC) = 1 / (1 – 0.8) = 1 / 0.2 = 5
real GDP = G x 5

We see that if the MPC is 0.8, any increase in government spending (G) will bring about a five times greater increase in output (Y). The same is true of a decrease in G. So if G increases by 100, Y increases by 5(100) = 500. If G decreases by 50, Y decreases by 5(50) = 250. To increase Y, the government must increase spending and to decrease Y, the government must decrease spending.

If the government wants to increase Y, should it increase or decrease taxes? Suppose the government decreases taxes. When T falls, national disposable income increases. Disposable income increases when people pay less in taxes and have more money to spend, creating an increase in consumption. However, consumption does not go up by the same amount that income increases. If taxes decrease by $100 million and income therefore goes up by $100 million, people will not spend all of this extra income. They will spend some of it and save some of it. The ratio of saving to spending depends on the MPS and the MPC.

When T falls, national disposable income goes up and results in an increase in consumption. An increase in consumption means that AD increases and firms produce more to meet this increase in demand. This new output gets sold and generates more income for the producers; they then spend this money (investments), causing another increase in consumption, another increase in AD and another increase in production. Once again, we have an economic effect that goes beyond the amount of the original change. The tax multiplier can help us evaluate the effect of this change in taxes.

Tax multiplier = – MPC / (1 – MPC)
real GDP = T x tax multiplier

Notice that this multiplier is negative. This means that if the government aims to increase Y, it should lower taxes. Also not all tax relief income gets spent; a certain percentage of it will be saved, depending upon the MPC. So the absolute value of the tax multiplier is smaller than that of the government spending multiplier.

If we set MPC equal to 0.8, as we did for the government spending multiplier:

Tax multiplier = – MPC / (1 – MPC) = -0.8 / (1 – 0.8) = -0.8 / 0.2 = -4
real GDP = T x -4

For the same MPC, the absolute value of the tax multiplier is smaller than that of the government spending multiplier. The absolute value of the tax multiplier when the MPC is 0.8 is 4, whereas the value of the government spending multiplier is 5. This means that to bring about the same increase in Y, the government will meed to make a larger change in T than it would have needed to make in G.

So if T falls by 100, Y will increase by 400: -4(-100) = 400. If T increases by 50, Y will fall by 200: -4(50) = -200. The negative sign indicates a decrease in T or Y, while a positive number indicates that it is rising. The tax multiplier is negative, which means that an increase in net taxes will lead to a decrease in real GDP demanded. The positive value of the government spending multiplier means that an increase in government spending leads to an increase in real GDP demanded.


Gov: LPA Research

What’s changing in the Republican health care bill?  Hoping to appease concerns by both conservative and moderate lawmakers, House GOP leaders are making changes to their health care bill ahead of Friday’s critical vote. The package of amendments was unveiled with many of the new provisions aimed at toughening Medicaid rules for adults, but making some allowances for the disabled and elderly covered by the program.


APMacro: Practice FRQ



Suppose that the United States economy is in a deep recession. Using a correctly labeled aggregate demand and aggregate supply graph, show the equilibrium price level and real gross domestic product. There is a debate in Congress as to whether to decrease personal income taxes by a given amount or to increase government purchases by this amount. Explain which of the two fiscal policies will have a larger impact on real gross domestic product. Explain how a decrease in personal income taxes will affect Real gross domestic product and the price level in the short run. Explain the mechanism by which an increase in net investment will change aggregate demand and long-run aggregate supply.


Gov: LPA Research

Across the nation, reaction to the 2010 health care legislation that made its way through the House seemed to echo the bitter division in Washington. While people referred to the legislation as “health care,” “health reform,” “health care insurance reform,” and “health insurance reform,” the actual title of the bill is something else entirely: the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010. Republicans see the new law as a government takeover produced by back room deals and rammed through Congress. Most Democrats hailed it as historic, and President Obama declared that the law will set in motion reforms that generations of Americans have fought for and marched for and hungered to see. Meanwhile, progressives who had long called for a Medicare for all system were disappointed by the legislation, which builds on the U.S.’s private, employer-based insurance system.

The American Health Care Act, backed by President Donald Trump and House Speaker Paul Ryan, would partially repeal and replace the Affordable Care Act, aka Obamacare, and could dramatically impact health insurance for tens of millions of Americans. The House GOP bill has some similarities to Obamacare. It requires insurers to take on customers regardless of any pre-existing condition. It provides subsidies to people, in the form of tax credits, to buy insurance on the individual market. And it tries to encourage people to stay insured. But the similarities end there. The bill spends less on fewer subsidies, reduces Medicaid spending by large amounts, and uses the savings to eliminate taxes on wealthier Americans and medical companies imposed by the Affordable Care Act.

Preferred Provider Organization (PPO)
Health Maintenance Organization (HMO)
group insurance market
individual insurance market
Health Savings Account (HSA)
Health Reimbursement Account (HRA)
Consolidated Omnibus Budget Reconciliation Act (COBRA)
Children Health Insurance Program (CHIP or SCHIP)
pre-existing condition
medical underwriting
medical bankruptcy

Major Players
Health Insurance Companies
Healthcare Providers (doctors, nurses, etc.)
Pharmaceutical Companies


APMacro: Practice FRQ



The unemployment rate in the country of Southland is greater than the natural rate of unemployment. Using a correctly labeled graph of aggregate demand and aggregate supply, show the current equilibrium real gross domestic product and price level in Southland. The president of Southland is receiving advice from two economic advisers about how best to reduce unemployment in Southland. Kohelis advises the president to decrease personal income taxes. What is the effect of the change in tax policy? Raymond advises the president to take no policy action. What would eventually happen to the price level and output.


Gov: Interest Groups

Interest Groups3
Americans join all kinds of groups that reflect their interests. When such groups seek to influence government, at any level, they are called special-interest groups or special interests. The term special interest refers to a particular goal or set of goals that unites the members of a group.

There are thousands of interest groups in the United   States. Although they differ in many respects, their basic goal is the same: they all try to persuade elected officials to take actions to support their interests. Special-interest groups fall into several categories, depending on their membership and goals. Americans join interest groups for various reasons. Some join for the information and benefits the groups offer. Many interest groups publish newsletters and host workshops and conferences for members. Some offer training that helps members qualify for higher-paying jobs.

All interest groups need both money and people, but they are organized and financed in many ways. Most interest groups have an elected board of directors or trustees who set policy and decide how the group’s resources will be used. Many groups have both national and state chapters, each led by their own boards or trustees. Funding methods vary among interest groups. Many economic and single-issue groups get most of their operating expenses from dues, membership fees, and direct mail fundraising campaigns. Some public interest groups get their primary funding from foundations or government grants.