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Fiscal Policy
Refers to changes in government
expenditures and/or taxes to achieve
particular economic goals, such as low
unemployment, price stability, and
economic growth.
Government expenditures is the sum of
government purchases and transfer
payments.
Crowding Out
Refers to a decrease in private expenditures that
occurs as a consequence of increased government
spending or the financing needs of a budget
deficit.
Economists who believe the crowding out
phenomenon exists argue that because of the direct
substitution of public services for consumer
spending or because of higher interest rates,
increases in government spending induce
consumers and investors to spend less.
Crowding Out
Complete Crowding Out occurs when the decrease
in one or more components of private spending
completely offsets the increase in government
spending.
Incomplete Crowding Out occurs when the
decrease in one or more components of private
spending only partially offsets the increase in
government spending.
Whether we are dealing with complete or
incomplete crowding out, the crowding out effect
suggests that expansionary fiscal policy will have
less impact on aggregate demand and Real GDP
than Keynesian theory predicts.
In Keynesian theory,
expansionary fiscal policy
shifts the aggregate
demand curve to AD2 and
moves the economy to
point 2.
If there is no crowding out,
expansionary fiscal policy
increases Real GDP and
lowers the unemployment
rate.
If there is incomplete
crowding out,
expansionary fiscal policy
increases Real GDP and
lowers the unemployment
rate, but not as much as in
the case of zero crowding
out.
If there is complete
crowding out,
expansionary fiscal policy
has no effect on the
Q&A
How does crowding out question the
effectiveness of expansionary demand-side
fiscal policy?
Do budget deficits raise interest rates?
How can an increase in the size of the
federal budget deficit affect the trade
deficit?
Q&A
Give an arithmetical example to illustrate
the difference between the marginal and
average tax rates.
If income tax rates rise, will income tax
revenue rise as well?