Question

During 2007-2009, the global economy experienced a severe recession. To deal with recessionary gaps in their economies, many countries implemented expansionary fiscal policies to increase aggregate expenditures. Consider the following hypothetical responses (the actual policies were different in each country).

In 2009, the government of the United States introduced a $675 billion stimulus package - additional government expenditures with no changes to the tax system. In Canada, the tax rate was reduced from 33 percent of GDP to 30 percent of GDP at a cost of $80 billion. Both policies cost about the same nominal dollar value per capita.

QUESTION 1a) (20 Points)

For each country, use the Desired Aggregate Expenditure and Actual National Income framework to illustrate (with a diagram) the impact of each policy on equilibrium expenditure and income. Explain how the government’s new policy alters equilibrium income.

Do a separate illustration for each country. Be sure to label each axis, all equilibrium points and every line or curve. Show the initial equilibrium, show how the policy changed Aggregate Expenditure and show the new equilibrium after the policy was introduced.

Answer 1

In the 2007-2009 global economic crisis, different countries have taken different strategies in terms of expansionary fiscal policy to control the effect of the crisis. so the USA has taken money spending of $675 billion to boost the aggregate demand. In the case of Canada, it has given a tax reduction of 3% a total cost of $80 billion. so both are expansionary policies that can be presented through aggregate expenditure and income. So in this case first for the USA, the initial equilibrium was E0, Income Y* with the aggregate expenditure of AE. so after the crisis, the government has implemented expansionary policy by adding $675 billion dollars. so there is a shift in aggregate expenditure, which boost the income and attain the potential level of income.

In case of Canada, the initial equilibrium is E0 where the income is Y* and the aggregate expenditure is AE so due to a reduction in tax there is an increment in disposable income and that will enhance the demand factor.so the new aggregate expenditure is AE1, the new potential equilibrium is E1 and income Y1.

If we analyze the policy change in both the country to boost its economy are different from each other.where one has adopted the policy of increase in government expenditure whereas the other country has adopted the tax cut. In these two policies the USA policy is progressive then Canada so in the given figure if we will compare both the potentiality is different on the income generation whereas the aggregate expenditure is also different due to its effectiveness. Both the equilibrium shows the effectiveness of the expansionary policy but USA's policy is more effetive then the Canada.