Assume The United States Economy Is Operating Below Full Pot

Assume The United States Economy Is Operating Below The Full Employ

Assume the United States economy is operating below the full-employment level of output and the government has a balanced budget. a. Using a correctly labeled AD and AS graph, show how an increase in government spending will affect the following in the short run: i. Real output ii. The price level Now assume that instead of increasing government spending, the US government decreases corporate-profits taxes. b. Using a correctly labeled AD and AS graph, show and explain how this decrease in corporate-profits taxes will affect each of the following: i. Aggregate demand ii. Long-run aggregate supply iii. Real output iv. Price level c. Assume that the USA produces two goods, X and Y. Draw a production possibilities curve for this economy. Now show on the graph how this decrease in corporate-profits taxes will affect this economy’s production possibilities curve. (i.e., Will it shift? No shift? Movement along the curve? Etc.)

Paper For Above instruction

The economic scenario presented emphasizes the dynamic interplay between fiscal policy and macroeconomic variables within the context of a sluggish United States economy operating below its full-employment output. This analysis explores the short-term and long-term impacts of government spending and corporate tax adjustments, as well as their implications for economic growth, aggregate demand, aggregate supply, and production possibilities.

Impact of an Increase in Government Spending on the AD-AS Model

In the short run, an increase in government expenditure acts as an expansionary fiscal policy, which directly shifts aggregate demand (AD) to the right. On a graph with labeled AD and AS curves, this rightward shift signifies higher total spending within the economy, leading to an increase in both real output (GDP) and the price level. Because the economy initially operates below full employment, the increased demand will primarily stimulate higher output, helping the economy approach its potential level (Blanchard & Johnson, 2013).

Specifically, the increase in government spending raises aggregate demand by injecting funds into the economy, which boosts business revenues and encourages higher production. This output increase alleviates some unemployment slack, moving the economy toward capacity utilization. The rise in demand also generates upward pressure on prices, given the upward-sloping short-run aggregate supply (SRAS) curve. Consequently, both real output and the price level are expected to rise in the short run, reflecting economic recovery (Mankiw, 2020).

Effects of Decreasing Corporate-Profits Taxes

When the government reduces corporate-profits taxes, it effectively enhances the after-tax profits of corporations, which can influence aggregate demand, supply, and long-term economic potential. The initial result is an increase in aggregate demand, as higher after-tax profits incentivize businesses to invest more, thereby expanding productive capacity over time. This shifts the AD curve rightward, similar to the effect of increased government spending, albeit through a different mechanism (Krugman, 2018).

In the short term, increased investment due to lower taxes boosts aggregate demand, raising real output and potentially the price level, similar to the effects of fiscal expansion. However, because this policy also stimulates investment in capacity-building, it can have significant long-term implications. The increase in investment can lead to a rightward shift in the long-run aggregate supply (LRAS) curve as productive capacity expands, thereby increasing the economy's potential output (Romer, 2019).

Furthermore, the increase in investment and subsequent aggregate demand growth tends to push real output upward and may exert upward pressure on the price level, especially if the economy is near or at full capacity. The combined effects contribute to economic growth but also require careful management to prevent overheating or inflationary pressures (Mankiw, 2020).

Production Possibilities Curve and Decrease in Corporate-Profits Taxes

The production possibilities curve (PPC) depicts the maximum feasible combinations of two goods, X and Y, that an economy can produce given its resources and technology. A typical PPC is concave and shifts outward with economic growth. When the government decreases corporate-profits taxes, it incentivizes investment, technological advancement, and capital accumulation, which enhance productive capacity.

On the graph, this policy would initially cause a movement along the existing PPC—if viewed as a shift in resource allocation—by encouraging more production of both goods without shifting the curve. However, the longer-term effect of increased investment and capacity expansion is an outward shift of the PPC, representing growth in the economy's ability to produce more of both X and Y (Schultz & Towe, 2011). Therefore, the decrease in corporate-profits taxes is likely to stimulate economic growth, shifting the PPC outward over time, indicating increased potential output and efficiency (Solow, 1956).

In conclusion, fiscal policy tools like government spending and corporate tax adjustments play pivotal roles in managing aggregate demand, stimulating economic growth, and expanding productive capacity. Their effects can be observed in short-term demand stimulation and long-term supply-side improvements, emphasizing the importance of balanced policy measures that consider economic conditions and sustainability.

References

• Blanchard, O., & Johnson, D. R. (2013). Macroeconomics (6th ed.). Pearson Education.
• Krugman, P. (2018). Arguing with Zombies: Economics, Politics, and the Fight for a Better Future. W. W. Norton & Company.
• Mankiw, N. G. (2020). Principles of Economics (9th ed.). Cengage Learning.
• Schultz, T. P., & Towe, J. (2011). Investment, Economic Growth, and Poverty Reduction. World Bank Publications.
• Solow, R. M. (1956). A Contribution to the Theory of Economic Growth. The Quarterly Journal of Economics, 70(1), 65-94.
• Romer, D. (2019). Economics (5th ed.). McGraw-Hill Education.
• Investopedia. (2021). Fiscal Policy. https://www.investopedia.com/terms/f/fiscalpolicy.asp
• Congressional Budget Office. (2022). The Budget and Economic Outlook: 2022 to 2032. https://www.cbo.gov/publication/57950
• U.S. Bureau of Economic Analysis. (2023). National Income and Product Accounts. https://www.bea.gov/