5 Steps to a 5 AP Macroeconomics 2019

Fiscal Policy, Economic Growth, and Productivity ❮ 127

Expansionary Fiscal Policy

When the economy is suffering a recession, real GDP is low and unemployment is high.

In the AD and AS model, a recessionary equilibrium is located below full employment,

as shown in Figure 10.1. If the government increases its spending or lowers net taxes, the

AD curve increases. Net taxes, if you recall, are tax revenues minus transfer payments.

Of course, if the government is using tax cuts, rather than government spending, to expand

the economy, the multiplier is smaller; so to get the same increase in real GDP, the size of

the tax cut must be larger than an increase in government spending.

KEY IDEA

Contractionary Fiscal Policy

If the economy is operating beyond full employment, and inflation is becoming a problem, the

government might need to contract the economy. This inflationary equilibrium is seen beyond

full employment, as shown in Figure 10.2. This can be done by decreasing government spend-

ing or by increasing taxes, both of which cause a leftward shift in AD. The economy should see

a little decrease in real GDP, but ideally a substantial decrease in the rate of inflation.

LRAS

SRAS

AD 0

AD 1

Price

Level

Real GDP

PL 1

PL 0

GDP 0 GDPf

Figure 10.1

Figure 10.2

LRAS

SRAS

AD 0

AD 1

Price

Level

GDPf GDP 0 Real GDP

PL 0

PL 1