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Introduction

  • The economy is almost constantly faced with an output gap that results in output being either above or below the level of equilibrium output. This is as a result of the business cycle, which fluctuates as time passes. 
  • The government uses either contractionary or expansionary fiscal policies to bring output levels back to equilibrium output. However, there are also factors known as automatic stabilizers that automatically help the economy reach equilibrium output regardless of government action.

There are three automatic stabilizers:

  1. Taxes
  2. Welfare
  3. Unemployment

Definitions

  • Taxes: Taxes refer to sums of money paid to the government by consumers and producers of goods and services, including sales tax, income tax, property tax, etc.
  • Welfare: Welfare is a government program that provides financial aid to people who are unable to support themselves financially as a result of their situation, including disability, old age, etc.
  • Unemployment: People who have recently lost their jobs and are actively looking for a new job(frictional unemployment) are eligible for temporary unemployment benefits as a result of their need.

How does it work?

  • When an economy is under an inflationary gap, more people move to higher tax brackets, while less people stay on welfare and procure unemployment benefits since the economy is overproducing goods and services. 
  • This results in consumers having less money to spend on goods and services, reducing the number of goods bought and sold and thus automatically decreasing the inflationary gap
  • When an economy is under a recessionary gap, more people move to lower tax brackets, while more people get onto welfare and procure unemployment benefits since the economy is underproducing goods and services. 
  • This results in consumers having more money to spend on goods and services, increasing the number of goods bought and sold and thus automatically increasing the inflationary gap
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