TAILIEUCHUNG - Ten Principles of Economics - Part 74

Ten Principles of Economics - Part 74. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 32 THE INFLUENCE OF MONETARY AND FISCAL POLICY ON AGGREGATE DEMAND 755 cause incomes earnings and profits all fall in a recession the government s tax revenue falls as well. This automatic tax cut stimulates aggregate demand and thereby reduces the magnitude of economic fluctuations. Government spending also acts as an automatic stabilizer. In particular when the economy goes into a recession and workers are laid off more people apply for unemployment insurance benefits welfare benefits and other forms of income support. This automatic increase in government spending stimulates aggregate demand at exactly the time when aggregate demand is insufficient to maintain full employment. Indeed when the unemployment insurance system was first enacted in the 1930s economists who advocated this policy did so in part because of its power as an automatic stabilizer. The automatic stabilizers in the . economy are not sufficiently strong to prevent recessions completely. Nonetheless without these automatic stabilizers output and employment would probably be more volatile than they are. For this reason many economists oppose a constitutional amendment that would require the federal government always to run a balanced budget as some politicians have proposed. When the economy goes into a recession taxes fall government spending rises and the government s budget moves toward deficit. If the government faced a strict balanced-budget rule it would be forced to look for ways to raise taxes or cut spending in a recession. In other words a strict balanced-budget rule would eliminate the automatic stabilizers inherent in our current system of taxes and government spending. I QUICK QUIZ Suppose a wave of negative animal spirits overruns the economy and people become pessimistic about the future. What happens to aggregate demand If the Fed wants to stabilize aggregate demand how should it alter the money supply If it does this what happens to the interest rate Why might the Fed

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