The effects of discretionary fiscal policy as per Keynesian model. Concept Introduction : Gross Domestic Product : It is the final value of all the final goods and services produced within the territorial boundaries of a nation in a given period of time. Discretionary Fiscal Policy: It is a tool used by the government to achieve equilibrium level of GDP during different economic situations. The policy mainly focuses on government spending and its taxation tools. A tax cut or an increase in government spending is an expansionary fiscal policy. A decrease in government spending and an increase in tax rates is a contractionary fiscal policy. These policies are used to achieve objectives of low unemployment rates, price stability, and economic growth .

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Chapter 13, Problem 13.1LO

To determine

:

The effects of discretionary fiscal policy as per Keynesian model.

Concept Introduction:

Gross Domestic Product: It is the final value of all the final goods and services produced within the territorial boundaries of a nation in a given period of time.

Discretionary Fiscal Policy: It is a tool used by the government to achieve equilibrium level of GDP during different economic situations. The policy mainly focuses on government spending and its taxation tools.

A tax cut or an increase in government spending is an expansionary fiscal policy. A decrease in government spending and an increase in tax rates is a contractionary fiscal policy. These policies are used to achieve objectives of low unemployment rates, price stability, and economic growth.

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Explanation of Solution

Keynesian economists argue that the intervention of government is necessary to correct the output gap. They assume that the private expenditure and government expenditure are not a substitute of each other.

An expansionary fiscal policy implies that the government has either increased their spending or reduced taxes to give a boost to the economy.

A higher spending will increase the aggregate demand directly and a tax cut would increase the disposable income (after tax income) of the consumers, which would in turn lead to an increase in the aggregate demand.

As a result, the aggregate demand will shift rightwards leading to an increase in the value of real GDP and price levels.

This policy is used to correct a recessionary gap or a negative output gap (actual GDP lower than the potential; GDP).

A contractionary fiscal policy implies that the government has either decreased their spending or increased taxes.

Reduced government spending will decrease the aggregate demand directly and a tax increase would decrease the disposable income (after tax income) of the consumers, which would in turn lead to a decrease in the aggregate demand.

As a result, the aggregate demand will shift leftwards leading to a decrease in the value of real GDP and price levels.

This policy is used to correct an inflationary gap or a positive output gap (actual GDP higher than the potential; GDP).

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