Welkers Wikinomics practice activities

2.4 Fiscal Policy

Automatic Stabilizer

Instructions: Study the graph below and answer the questions that follow. Assume Canadas
target Economic growth rate over the long-run is 2.5% per annum.

Data source: World Bank via Googles public data explorer1

1. For the periods highlighted in the chart, explain one demand factor and one supply factor
that may account for the fluctuations from the countrys long-run average growth rate.
a. Yellow and Purple:
Demand factor: Increases in consumption, investment or net exports

Supply factor: Increases in labor productivity

b. Blue and Green:

Demand factor: Decreasing consumption, investment or net exports

Supply factor: Rising wages

The table below shows Canadas income tax rates for different income levels:
15% on the first $44,701 of taxable income
22% on the next $44,702 of taxable income (on the portion of taxable income
between$44,702 and $89,401)
26%on the next $89,402 of taxable income (on the portion of taxable income
between$89,402 and $138,586)
29% of taxable income over $138,586

1
https://goo.gl/DX6eJu
 Welkers Wikinomics practice activities

2. Referencing the table above, explain how Canadas tax receipts would have changed
during the highlighted periods.
a. Yellow and Purple:
higher tax receipts as more Canadians are earning higher incomes, paying
more taxes.

b. Blue and Green:

smaller tax receipts as Canadian incomes fall, meaning people pay less
income tax.

3. Explain how government expenditures on unemployment compensation would have

been affected during the highlighted periods.
a. Yellow and Purple:
Unemployment rate would decrease, meaning fewer Canadian workers are
eligible for unemployment compensation, resulting in the government spending
less during these periods.

b. Blue and Green:

Decreasing output would have resulted in less demand for labor, causing
unemployment to rise and more Canadians collecting unemployment
compensation

4. How do progressive income taxes and unemployment compensation programs act as

automatic stabilizers during periods of economic growth that vary from a nations long-
run trend growth rates?
a. During slowdowns or recession:
Taxes decrease automatically, which means workers have more disposable
income can consume more than they usually would offset a decrease in AD
during a slowdown or recession. Unemployment compensation puts more
income into the pockets of those who lose their jobs during slowdowns, also
helping prop up consumption.

b. During expansions:
Taxes increase automatically as more people have jobs and earn higher
incomes, leaving them with less disposable income than they would have
otherwise, offsetting the inflationary effect of rapid economic growth.
Unemployment compensation decreases as more people have jobs, reducing
the amount by which the incomes of the newly employed workers rise and
helping prevent the high inflation that could otherwise result.
 Welkers Wikinomics practice activities

5. Outline the advantages of having built-in fiscal stabilizers like progressive taxes and
unemployment compensation when compared to depending solely on discretionary fiscal
policies to promote stable growth.
Built-in stabilizers have an immediate impact on the level of disposable income and of
tax receipts when a countrys GDP growth rate accelerates or slows, acting as a
countercyclical measure to reduce inflationary and deflationary pressures. In contrast,
discretionary fiscal policies, which require government policymakers to debate and
decide on appropriate responses to changes in the growth rate, take time to enact and
may come along too late to prevent price level instability.