Consider the situation where aggregate demand has risen sharply, causing the macro equilibrium to occur at a level of output above potential GDP. All of these things serve to buoy aggregate demand and prevent it from falling as far as it otherwise would. Additionally, since their income has fallen, so have their tax liabilities. As individuals are laid-off, they qualify for unemployment compensation, food stamps and other welfare programs. Consider, though, the effects of automatic stabilizers. The lower level of aggregate demand and higher unemployment will tend to pull down personal incomes and corporate profits, which would tend to reduce consumer and investment spending, further cutting aggregate demand and GDP. Suppose aggregate demand were to fall sharply so that a recession occurred. This has the intent to cushion the economy from changes in the business cycle.Īutomatic stabilisers may include the use of a progressive tax structure under which the share of income received in taxes is higher when income is high and drops when income drops due to recession, job loss, or investment failures.Īutomatic stabilizers include unemployment insurance, food stamps, and the personal and corporate income tax. They may also put more money back into the economy in the form of government spending or tax refunds when economic activity slows down, or revenues fall. Through their normal operation, these policies take more money out of the economy as taxes during periods of rapid growth and higher income. Automatic stabilisers are so-called because they serve to regulate economic cycles and are triggered automatically without further government action.Īutomatic stabilisers are designed primarily to combat negative economic shocks or recessions, although they may also be intended to "cool off" and expand the economy or battle inflation. Progressively graduated corporate and personal income taxes and payment schemes, such as unemployment insurance and welfare, are the known automatic stabilisers.
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