1. Fiscal Policy and Aggregate Demand
Fiscal policy involves the taxing and spending policies of the government.

1. Shifts in the aggregate demand curve are caused by changes in government spending (directly) and taxes (indirectly through consumption) as they determine new levels of aggregate expenditures at various price levels.
   
   Teaching Strategy: Be sure to show your students how the aggregate supply curve comes into play to blunt changes in real GDP that result from changes in aggregate demand.
   
   
2. A multiplier effect on real GDP may be caused by a change in government spending or taxes. The extent to which this occurs depends on price level effects and the manner in which the government finances its spending.
   
   Teaching Strategy: Show that the initial effect of a change in government spending causes a change in real GDP by the same amount. The multiplier summarizes how this change in real GDP results in subsequent changes in spending and real GDP.
   
   
3. Government spending financed by tax increases: Government spending increases aggregate expenditures directly, but higher taxes lower aggregate expenditures indirectly.
   
   Teaching Strategy: Work through the balanced-budget effects graphically, assuming first that aggregate supply remains constant and is perfectly elastic, then allowing for a relatively inelastic aggregate supply, and finally allowing for a reduction in aggregate supply in response to the tax increase.
   
   Teaching Strategy: You may wish to point out that, in the short run, tax changes do not seem to have a large effect on aggregate supply. In the long run, however, tax changes may have an impact on capital accumulation, thus shifting the long-run aggregate supply curve.
   
   
4. Government spending financed by borrowing: Borrowing to finance government spending can limit the increase in aggregate demand.
   
   Teaching Strategy: The following exercise can be used to illustrate the concept of Ricardian equivalence. On one side of a piece of paper print Received from the Government: $100 in proceeds from a debt issue and on the other side print Pay to the Government: $100 to retire debt. Hand them out and ask the students to read both sides and decide if they would alter their spending if they received such a note from the government in the mail. Show how this exercise is an example of the concept of Ricardian equivalence.
   
   
5. Crowding out is the situation where the government borrows to finance its spending, so interest rates rise, thus discouraging private borrowing, investment, and consumption.
   
   

2. Fiscal Policy in the United States

1. The budget process determines fiscal policy.
   
   
2. The historical record: Fiscal policy comprises discretionary fiscal policy and automatic stabilizers.
   
   
3. Deficits and the national debt: A deficit represents a net increase in the national debt.
   
   

• Deficits, interest rates, and investment: Increased government borrowing raises interest rates, which can depress investment.
  
  
• Deficits and international trade: Growing deficits crowd out net exports.
  
  
• Interest payments on the national debt: Interest payments on the national debt have claimed an increasing share of government expenditures.
  
  
• Automatic stabilizers: Progressive income taxes and transfer payments are two examples of elements of fiscal policy that change automatically as real GDP changes.
  
  

Teaching Strategy: Point out that automatic stabilizers work with less of a lag than discretionary policy does. Discuss the differences among progressive, proportional, and regressive taxes.


3. Fiscal Policy in Different Countries

1. Government spending has accounted for a growing share of gross domestic product in all industrial countries.
   
   Teaching Strategy: Take some time to point out the differences in the composition of government spending across countries. If you have international students in your class, you may wish to ask them to share information about their national governments fiscal policy.
   
   
2. Taxation has two typesdirect taxes (on individuals and firms) and indirect taxes (on goods and services).