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Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364

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BuyFindarrow_forward

Principles of Economics 2e

2nd Edition
Steven A. Greenlaw; David Shapiro
ISBN: 9781947172364
Textbook Problem

What is the main advantage of automatic stabilizers over discretionary fiscal policy?

To determine

The main advantages of automatic stabilizers over discretionary fiscal policy.

Explanation

Automatic stabilizers are economic parameters that act automatically to counter the fluctuations in GDP. It means the automatic stabilizers increase aggregate demand in periods of economic slowdown and decrease aggregate demand in periods of economic boom. Some examples of economic stabilizers are government spending, taxes, unemployment insurance, food stamps, etc.

Let us first discuss government’s expansionary and contractionary fiscal policies.

An expansionary fiscal policy of the government refers to use of government spending to increase the aggregate demand, output, employment and prices in the economy. It includes:

  1. cuts in business taxes to increase after tax profits
  2. cuts in individual income taxes to increase the disposable income and hence to increase the consumption
  3. increasing government purchases of final goods and services to increase aggregate demand directly.

A contractionary fiscal policy of the government refers to use of government spending to increase the aggregate demand, output, employment and prices in the economy. It includes:

  1. Increase in business taxes to reduce after tax profits
  2. Increase in individual income taxes to decrease the disposable income and hence to increase the consumption
  3. Reducing government purchases of final goods and services to reduce aggregate demand directly.

Automatic stabilizers also work in the same way without the use of discretionary fiscal policy. In the case when economy has less than potential GDP, the automatic stabilizers work as follows. On the spending side, a reduced aggregate demand would mean higher unemployment and weak domestic demand which would stimulate government expenditure on unemployment insurance, public works, welfare schemes, etc...

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