Introduction

According to an article found on the federal budget 2016 of the financial post website. The
Canadas liberal government will be spending $11.9 billion over two years to upgrade and repair
infrastructure for instance, public transit infrastructure fund, affordable housing, municipal
capacity building and so on. Ultimately, this issue illustrates the increasing in government
spending will cause an increase in aggregate demand as AD. Whereas, AD is represented by this
equation, AD = Consumption + Investment + Government Spending + (Exports - Imports).
Being a component of aggregate demand, it would stimulate the economy. It is because the
increasing government spending has an influence on aggregate expenditure and causing a boost
in the short run, in economy shown in the diagram below Fig10.1. Based on the article, we know
that there is a budget deficit in Canadas economy. The Canadas government use fiscal policy to
monitor the economy.
Budget Deficit
First of all, budget is defined as a state government budget is an annual statement of the revenues
and expenses of a state government together with the laws and regulations that approve or
support those revenue and expenses (TAGGART.M, 1953). Every countrys government will read
out a budget annually. In general, Canadas government revenue is less than the government
expenditure which known as budget deficit. However, when the government revenue is greater
than the government expenditure. We called it as budget surplus. In todays world, almost all
countries have budget deficit (Findlay. C, 1953). It depends on the government expenditure and
tax revenue. We could measure Canadas budget deficit through percentage of GDP to find out
whether the deficit increasing or decreasing. According to our studies, there is a positive
relationship between real GDP as well as tax revenue. When Canadas real GDP increase, its tax
revenue will increase at the same time. On the others hand, there is a negative relationship
between government expenditure and real GDP. When real GDP is increased, the Canadas
government expenditure will decrease. There are two relationships that related to the diagram
10.1. From the diagram 10.1, the red area is represent as budget deficit. While, the opposite
orange area will take place when a country has a budget surplus. Budget has a big influenced by
the real GDP growth. Based on the article, we know that Canada is trying to increase the real
GDP by 0.2 percent for 2016 and 0.4 percent for 2017. Thus, if Canadas real GDP is sustainably
growing then government will reduce its expenditure and increase the revenue. Consequently,
when Canadas government focuses more on government spending rather than government
revenue. Then, the budget deficit of Canada will become bigger. Nevertheless, there is a balanced
budget in the diagram below 10.1 when tax revenue and government expenditure intersect, at Y1.
Fiscal Policy
Moreover, there is a recession gap from Y0 to Y1 in the Canadas economy which mean the
Canadas GDP is under the full employment rate. In order to curb the recession gap in the
economy, Canadas government implements discretionary expansionary fiscal policy to stabilize
the economy. Fiscal policy is a meaning of the use of taxation as well as government spending to
influence the economy (David.N, 2008). This expansionary fiscal policy can be done by
increasing government spending or reduce taxation. Therefore, when the government spending
increase, AD is increasing at the same time. This will cause the AD curve shifts to the right from
AD0 to AD1. The shifting of AD curve resulting the effect of real GDP from Y0 to Y1 and
causing the Price level increase from P0 to P1. Whereas, the main reason of the increase in
Canadas GDP is because Canadas government increase the government expenditure on

infrastructure causes more money flowing back to households as income and households will
have more disposable income to spend. As we can see from the diagram 10.2, AD1 is greater than
SAS0 from point X to point Y. obviously, there is a shortage from Z to Y in the economy. Price
should increase from P0 to P1 in order to curb the shortage. When price increase resulting a fall
in the quantity aggregate demanded from point Y to point Z, as there is a fall in real wealth. In
this case, if the decreases of real wealth has decrease both quantity of consumption and quantity
of aggregate demand. When there is an increases in price, there will be an effect which known as
substitution effect. The substitution effect has separate into two effects, which are in-temporal
effect, and international effect. Regarding to in-temporal effect, an increases in price will cause
an increase in the interest rate. This condition encourages households to save more for tomorrow
as well as consume less for today. Therefore, when there is a delay in consumption plan, the
quantity of aggregate demand will drop. In term of international effect, domestic goods become
more expensive when the price increase, so people will try to replace domestic goods with
foreign goods. When people will not willing to buy domestic goods then quantity of aggregate
demand declined. Besides that, when there is a price increases, quantity of short run aggregate
supply increase. Since money wages is fixed in the short run. Thus, price is equal to revenue. In
addition, when both price and revenue increase will lead an increase in quantity of short run
aggregate supplied from point X to point Y. The economy will move back to full employment at
Point Y. While point Y is long run equilibrium too. The recession gap is solved through fiscal
policy. This policy is used when the government wants to boost its economy.
Keynesian Income & Expenditure Model
Apart from that, Canadas government increase government expenditure by 11.9 billions. Since
government spending is an autonomous expenditure so this will lead the AE curve shift upward
by increasing 11.9 billions. When the Canadas GDP remain at the same price, there is an
inventory shortage from point X to point Z in the economy. Its indicating AE1 is greater than Y1
that causes inventory shortage. If Canadas government just leave the economy by increasing
government expenditure then its will not moving the economy into a new equilibrium at Y in the
diagram shown below 10.3. Whenever there is a shortage, multiplier effect do help to move the
economy into new equilibrium. This effect will signal firm to increase their production. When the
firm should increase the production, they need to hire more workers in order to achieve the
targeted production. If more people had been employed which means their income increase then
this will increase induced consumption that is bY. Households will spend more when they get
more income. Furthermore, this will result in an increase in aggregate expenditure that known as
AE. Besides, it is indicate the movement from Z to Y which known as multiplier effect. Thus, this
shows the economy cannot move to the new equilibrium without multiplier effect.
Conclusion
In general, the impact of dicretionary expansinary fiscal policy by Canadas government
increasing the governemnt expenditure. An increase in aggregate demand causing the total output
to increase. Its has achieve a stable economic growth in Canada. Further, the economy has
achieved full employment rate. So, the increase in Real GDP in Canda will give a rise to
employment rate. This point out that there will be more production in the economy. After that,
government can start to increase the tax revenue in order to decrease the budget deficit. Lastly,
fiscal policy is a important tool for every country to stabilise the business cycle whenere there is a
inflationary gap or recessionary gap (David.N, 2008).
Appendix

Reference List

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David N. Weil. 2008. library economic liberty. [ONLINE] Available
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David N. Weil. 2008. library economic liberty. [ONLINE] Available

at:http://www.econlib.org/library/Enc/FiscalPolicy.html. [Accessed 9 June 2016].
McTaggart. 1953. Macroeconomics fourth edition. [ONLINE] Available
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