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Contractionary fiscal policy - Coggle Diagram
Contractionary fiscal policy
when the economy is in an inflationary gap and real GDP output is being produced at two faster rate
causing excessive inflation
restrict aggregate demand and lower equilibrium total output thus minimising the damaging effects of inflation on the economy.
spending multiplier
1 / MPS
MPS (Marginal propensity to save)= change in sacving / change in income
tax multiplier
MPC / MPS
MPS (Marginal propensity to consume) = change in consumption / change in income
also known as fiscal restraint
government implements contractionary fiscal policy with the intention to reduce aggregate demand in order to accomplish the goals of
decreasing real GDP output
stabilising price levels
can be visualised by leftward shift of the aggregate demand curve
can also be visualised by movement right word along the short run Phillips curve (inverse relationship between rates of unemployment and corresponding rates of rises in wages that result within an economy)
indicates a decrease in the inflation rate and an increase in the unemployment rate at the same time
contractionary policy options
decrease government spending
increase personal taxes
both policies will take income out of the economy and decrease consumer spending and investment spending by firms
reduce aggregate demand eliminate job opportunities and slow real GDP growth
fiscal restraint
increases the unemployment rate decreases income and consumption levels and reduces the standard of living
decreases income and consumption levels
decreases real GDP output increases the unemployment rate decreases income and consumption levels and reduces the standard of living
reduces the standard of living
reduces aggregate demand
also cause deflation
increases real wages as each dollar earned by workers has more purchasing power
leads to an increase in net exports as foreign consumers buy more exports because there now less expensive
also leads to budget surplus when government decreases expenditures increases personal taxes or uses a combination of both
government will have more revenue than it needs to fund its new expenditures and so it no longer borrows money this will lead to surplus spending which will
drive down real interest rates in the local funds market
domestic firms will increase investment spending in order to take advantage of paying lower interest on every dollar they borrow
leading to crowding in (occurs when higher government spending leads to an increase in economic growth and therefore encourages firms to invest due to the presence of more profitable investment opportunities.) in the aggregate economy thank you so much for watching