Fiscal policy and macroeconomic indicators

This exercise is appropriate for any entry-level economics class or a principles of macroeconomics class. It can be used after students have been introduced to the following topics: business cycles, fiscal policy, aggregate model. It can be used in a review class or as an end-of-term exercise as it will have students comparing all the consequences on macroeconomic indicators of each specific policy choice.

Students should already have been introduced to macroeconomic models as they will need to indicate where the economy is relative to full-employment, use a model to demonstrate their reasoning, and indicate if there are additional factors that might influence fiscal policy choices.

Overview

In this exercise students will identify the state the economy is in and evaluate the effectiveness of different fiscal policies. They will use graphs of the AD/AS model to decide whether the economy is at full employment output or not and make suggestions on how to improve the economy by using the two standard fiscal policy options. Additionally they will be asked to explain how fiscal policy can affect macroeconomic indicators.

Expected Student Learning Outcomes

Through this exercise students will use macroeconomic models to evaluate policy recommendations.

Information Given to Students

The economy of your country has recently come out of a recession. The country has seen a decrease in unemployment from 9% last year to 7% this year. The goal of unemployment is 5%. At the same time, real GDP growth was 1.5% last year and 2.3% this year. This year consumption has only grown by 1% and investment has remained stable. The country has had a trade deficit over the past years. Inflation has increased from 1% last year to 1.8% this year . In order to come out of the recession the government has increased spending over the past years which resulted in an increase in its national debt.

In order to improve economic outcomes, which of the following policies should be adopted by your government? In choosing a policy, identify your goals for each economic statistic listed above.

A) Expansionary fiscal policy
B) Contractionary fiscal policy
C) Allow the economy to self-adjust

Student handout fiscal policy AE (Acrobat (PDF) 5kB Aug10 18)

This activity requires the AE to be printed out and handed to the teams along with four cards with the letters of each option to use for simultaneous reporting at the end of the activity.
Students should have 20-30 minutes to discuss in groups of 4-5 and allow for another 20-30 minutes for debriefing. If class size is small this activity could fit in an entire class period (60-90 minutes).

After students simultaneously report their findings, they will take turns to present their reasoning behind their choice. They should all have reported their answers by using the appropriate graphs and making notes. Students should use the macroeconomic models studied at this point in the course with a focus on using the equation of GDP = C+I+G+X-I. Teachers could collect all the notes and grade them.

After all answers have been presented the discussion could be led by using some of the following questions:
What are the four macroeconomic objectives of an economy? What state is this economy in? If you chose to apply fiscal policy what exactly did you decide to do to taxes and government spending? How do these changes lead to change in the economic indicators provided in this AE? What is the effect of each of these choices in GDP, inflation, unemployment and current balance? What more information would you need in order to make a more informed policy suggestion?

When the assigned time for the activity is over teams will simultaneously report their answers by showing the equivalent answer card. After they report their findings each team will have to explain how they came to selecting their answer. It is advised that the reporter from each team should be randomly chosen on the spot so that all students during the activity equally participate and can justify their teams' choice in the end.
During the activity the teacher should circulate the classroom and try to clarify the activity for those who might be having issues applying the economic theory they have learned into choosing an answer.

Instructors should use any economics textbook that they have access to and assign the chapters on business cycles, economic growth, measurement of GDP and fiscal policy to students. If the instructors prefer they can use some of the following videos that cover some of these topics:

What is GDP

The aggregate demand curve

AD-AS model

Introduction to fiscal policy