A country’s economy is continually buffeted by shocks to aggregate demand and aggregate supply. AD shocks come from households, firms, governments, and foreign buyers. They change their spending patterns because the causal variables discussed in Chapter 3 change and impact them. These changes in aggregate demand are often large and persistent enough to become the subject of economic policy. Should governments intervene in the economy and attempt to bring aggregate demand back to a normal and sustainable level, or one that the government deems more appropriate? If so, monetary and fiscal policies are often used to stabilize AD changes.

Fiscal policy refers to the government’s use of taxation, spending, and regulatory policies to achieve its economic and political goals. As with monetary policy, there are many issues and controversies that relate to the use of fiscal policy. Since these issues and controversies play out in the political arena daily, business planners need to pay attention, because the results will come to affect them. Fiscal policies of the past and expected policies of the future can have pronounced impacts on interest rates, spending, profits, exchange rates, and many other aspects of the business environment. This chapter develops the basic terminology, concepts, and theories that relate to fiscal policy. It explains how fiscal policy affects aggregate demand and how the government can use it to counteract business-cycle fluctuation.

In the new world of international trade, the playing field is hardly level. The richer countries have relatively low trade barriers for most goods and commerce, but cling to protection for selected sectors of the economy, especially their farmers, services, and their airlines. These countries enjoy the trade advantages of having high-quality transportation and communication networks, the best technology, and the most educated workers. Developing countries, in contrast, seek to achieve equality in infrastructure, capital, and labor, but know it will take decades to catch up. In the meantime, they also feel the need to protect many of their young industries from the full force of the industrial nations, while demanding access to the markets of those countries for their agricultural and food products.

Two World Wars were sufficient to create a large void in international trade for about forty years. While a cold war and various hostilities prevailed after the late 1940s, international trade and capital flows resumed and grew remarkably. The fall of the Berlin Wall, symbolic of the end of the Cold War, intensified interest and growth in trade in the early 1990s and we find us now in a world where almost all countries feel quite free to trade with any of the others. We trade anything and everything. We trade old and new goods. We trade each other’s financial assets and we open up factories, stores, and offices almost any place we want.