#AP Macroeconomics: Fiscal Policy - Your Night-Before-the-Exam Guide 🚀

Hey, future AP Macro superstar! Let's get you feeling confident and ready to ace this exam. This guide is designed to be your go-to resource for a quick, effective review of fiscal policy. Let's dive in!

#What is Fiscal Policy?

Fiscal policy is how the government manages the economy using two main tools:

1. Government Spending: Direct purchases by the government (e.g., infrastructure, defense).
2. Taxation: How the government collects revenue from individuals and businesses.

There are two main types of fiscal policy:

• Expansionary Fiscal Policy: Used during recessions to boost the economy by:
  • Increasing government spending ⬆️
  • Decreasing taxes ⬇️
• Contractionary Fiscal Policy: Used during inflation to cool down the economy by:
  • Decreasing government spending ⬇️
  • Increasing taxes ⬆️

#Discretionary vs. Non-Discretionary Fiscal Policy

• Discretionary Fiscal Policy: Deliberate actions by Congress to change AD through new spending or tax laws. Think of stimulus checks during COVID-19. These policies can be subject to lags.
• Non-Discretionary Fiscal Policy: Automatic stabilizers already in place, like social security, welfare, and unemployment benefits. These kick in automatically when needed.

#Fiscal Policy and Economic Gaps

Fiscal policy is used to correct the economy when it's not at its potential output. This means addressing:

• Recessionary Gap: Economy is producing less than its potential. High unemployment, low output.
• Inflationary Gap: Economy is producing more than its potential. High inflation, potential overheating.

#Example Scenario

Let's say the economy is in a recession, producing $150 billion, but its potential is$200 billion. The goal is to close that $50 billion gap. The government must decide whether to use government spending or taxation to correct the situation.$

#Types of Fiscal Policies in Detail

#Expansionary Fiscal Policy

Expansionary policy is like giving the economy a boost. It's used to combat recessions by:

• Increasing Government Spending: More money spent on infrastructure, education, etc.
• Decreasing Taxes: People have more disposable income to spend.

This shifts the AD curve to the right, increasing output and reducing unemployment. However, it can also cause a rise in price levels (inflation).

<common_mistake> Remember, tax cuts need to be larger than spending increases to have the same impact because of the tax multiplier. </common_mistake>

#Visualizing Expansionary Policy

• AD1: Initial recessionary equilibrium.
• AD2: Shifted AD after expansionary policy, moving the economy towards full employment.

#Contractionary Fiscal Policy

Contractionary policy is like putting the brakes on the economy. It's used to combat inflation by:

• Decreasing Government Spending: Less money spent by the government.
• Increasing Taxes: People have less disposable income to spend.

This shifts the AD curve to the left, decreasing price levels. However, it can lead to a slight decrease in real GDP.

#Visualizing Contractionary Policy

• AD1: Initial inflationary equilibrium.
• AD2: Shifted AD after contractionary policy, reducing inflation.

#Calculating Fiscal Policy Changes

To determine how much to adjust spending or taxes, we use multipliers:

• Spending Multiplier: How much total spending increases for each dollar of government spending. Formula:1/MPS$* [object Object] How much total spending changes for each dollar change in taxes. Formula:$MPC/MPS$<memory_aid> Remember: [object Object]pending multiplier is [object Object]impler (1/MPS), while the [object Object]ax multiplier is a bit more [object Object]ricky (MPC/MPS). </memory_aid>$

#Example Calculation

Let's say the Marginal Propensity to Consume (MPC) is 0.5. This means the Marginal Propensity to Save (MPS) is also 0.5 (since MPC + MPS = 1).

• Spending Multiplier: 1 / 0.5 = 2. For every1 of government spending, the economy grows by $2. * [object Object] 0.5 / 0.5 = 1. For every$1 decrease in taxes, the economy grows by $1. To close the$50 billion recessionary gap:

• Government Spending: $50 billion / 2 (multiplier) =$25 billion increase in spending.

• Tax Cut: $50 billion / 1 (multiplier) =$50 billion decrease in taxes.

#Final Exam Focus

Okay, you're almost there! Here's what to focus on:

• High-Value Topics:
  • Understanding the difference between expansionary and contractionary fiscal policy.
  • Calculating spending and tax multipliers.
  • Analyzing the effects of fiscal policy on AD, price level, and real GDP.
  • Distinguishing between discretionary and non-discretionary policy.
• Common Question Types:
  • Multiple-choice questions on identifying the correct fiscal policy for a given economic situation.
  • FRQs requiring you to graph and explain the effects of fiscal policy.
  • FRQs involving multiplier calculations and policy recommendations.
• Last-Minute Tips:
  • Time Management: Don't spend too much time on one question. Move on and come back if you have time.
  • Common Pitfalls: Be careful with the tax multiplier. It's smaller than the spending multiplier.
  • Strategies: Practice drawing AD/AS graphs and explaining shifts. It's key to scoring well on FRQs.

Pay extra attention to the multiplier effect and how it impacts the magnitude of fiscal policy changes.

#Practice Questions

Practice Question

Multiple Choice Questions

1. Which of the following fiscal policies would be most effective in combating a recession? (A) Increasing taxes and decreasing government spending (B) Decreasing taxes and increasing government spending (C) Increasing taxes and increasing government spending (D) Decreasing taxes and decreasing government spending (E) Maintaining current tax and spending levels

2. If the marginal propensity to consume (MPC) is 0.8, what is the value of the spending multiplier? (A) 0.2 (B) 0.8 (C) 1.25 (D) 5 (E) 10

3. An economy is experiencing high inflation. Which of the following fiscal policies would be most appropriate? (A) Increase government spending (B) Decrease taxes (C) Increase taxes (D) Increase the money supply (E) Decrease interest rates

Free Response Question

Assume that the U.S. economy is currently in a recessionary gap. The current level of real GDP is $1,000 billion, while the full employment level of real GDP is$1,200 billion. The marginal propensity to consume (MPC) is 0.75. (a) Draw a correctly labeled aggregate demand and aggregate supply graph showing the current recessionary gap.

(b) Calculate the spending multiplier.

(c) Calculate the tax multiplier.

(d) Calculate the change in government spending required to close the recessionary gap.

(e) Calculate the change in taxes required to close the recessionary gap.

(f) Explain why a change in government spending is likely to have a greater impact on real GDP than an equivalent change in taxes.

Answer Key

Multiple Choice

1. (B)
2. (D)
3. (C)

Free Response

(a) Graph should show: The AD and SRAS curves intersecting to the left of the LRAS curve, indicating a recessionary gap. The x-axis should be labeled "Real GDP" and the y-axis should be labeled "Price Level." (2 points)

(b) Spending Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.75) = 1 / 0.25 = 4 (1 point)

(c) Tax Multiplier = MPC / (1 - MPC) = 0.75 / (1 - 0.75) = 0.75 / 0.25 = 3 (1 point)

(d) Change in Government Spending = $200 billion / 4 =$50 billion increase (2 points)

(e) Change in Taxes = $200 billion / 3 =$66.67 billion decrease (2 points)

(f) A change in government spending has a greater impact because it directly increases aggregate demand, whereas a tax cut may lead to some savings, reducing the overall impact on spending. (2 points)

You've got this! Go into that exam with confidence, and remember everything we've covered. You're prepared, you're smart, and you're ready to rock! 🌟