C719 Macroeconomics - Module 8

Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to .75, there would be a _____ in taxes needed to close the recessionary gap and restore full employment.

$100 decrease

If a politician is seeking to reduce unemployment and increase economic growth prior to an election, the fiscal policies that would most likely achieve these goals would be to _____ government spending and _____ taxes.

increase; decrease

The best example of an expansionary fiscal policy, designed to increase aggregate spending, is

increased public spending on infrastructure and a reduction in the income tax.

In a progressive tax system, the percentage of taxable income paid in taxes _____ as income increases.

increases

The goal of fiscal policy is to

influence employment, inflation and economic growth.

Assuming a progressive income tax, an increase in household income means families must pay _____ in taxes, which _____ their disposable income. Conversely, a decrease in household income means families must pay _____ in taxes, so the decrease in disposable income is _____ than if their tax rates had remained the same. As a result, the reduction in household spending is _____, helping to limit the downturn in the economy.

more; lowers; less; smaller; smaller

If the impact of expansionary fiscal policy is delayed until the economy has already recovered by itself, it is possible that policy intended to combat

recession may simply fuel inflation.

Fiscal policy is most effective when policy lags are

short

Fiscal policy is most effective when policymakers are motivated to pursue actions

that improve the economy's performance.

Automatic stabilizers are

put into place and left to respond automatically to changes in the level of economic activity.

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Macroland's constitution stipulates that the budget must be balanced, so an increase in government spending must be matched by an increase in taxes to pay for it, or a decrease in taxes must be matched by a decrease in spending. The government has decided to increase government spending to fill the recessionary gap of $400,000. What will the increase in spending and taxes be if the budget is balanced and the recessionary gap is filled when the marginal propensity to consume is .8?

$400,000

Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to .75, there would a _____ in government spending needed to close the recessionary gap and restore full employment.

$75 increase 74 x 4 = 300

Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to 0.75, the value of the tax change multiplier is

-3 {-0.75/(1-.75)}

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Macroland's government decides to cut taxes as its fiscal policy, instead of increasing government spending. What is the tax multiplier and how big a tax cut is needed to fill the recessionary gap of $400,000, when the marginal propensity to consume is .8?

-4; $100,000

Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to 0.75, the value of the government expenditure multiplier is

4 [1/(1-.25)]

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. To reach the full employment output, the economy needs to increase by $400,000. What is the spending multiplier and the amount government spending would have to increase to reach the full employment equilibrium, when the marginal propensity to consume is 0.8?

5:; $80,000

According to Keynesian theory, which of the following actions will be most expansionary?

A $10 billion increase in government spending

Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to .75, what change in government spending and taxes can close the recessionary gap and restore full employment, while maintaining a balanced budget?

A $300 increase in both government spending and taxes

According to the permanent income hypothesis, which of the following is true about its effect on output?

A permanent tax cut will have the largest effect on output.

_____ partially offset changes in private spending and tend to reduce fluctuations in output and employment and are triggered by changes in the economy. Therefore, they _____ require further action by Congress

Automatic stabilizers; do not

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Macroland's government decides to follow the Keynesian economist's advice and will increase government spending. The government plans to borrow the funds to pay for this new government spending. When it enters the loanable fund market, it will be one of the biggest borrowers in the market. Because of this, the Classical economist argues that the spending will not stimulate the economy. Why does the Classical economist think this?

Borrowers will prefer the safety of loaning to the government crowding out loans to private borrowers decreasing investments, which will decrease aggregate demand.

_____ economists argue that it is difficult, if not impossible, for the government to determine exactly the amount of fiscal policy necessary to reach the full employment levels. _____ economists believe that active fiscal policy is a valuable tool for stabilizing economic activity.

Classical; Keynesian

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. The Keynesian economist suggests several possible ways to end the recession using discretionary fiscal policy. Those ways include which of the following?

Decrease taxes or increase government spending.

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. True or false. The Classical economist believes that fiscal policy is necessary because the private sector during a recession will not have the money to increase spending, thereby stimulated the economy.

False - Classical economists believe that if the government is not heavily involved with regulating the economy, the economy can self heal, although it may take some time.

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. True or false. Keynesian and Classical economists agree on the effectiveness of fiscal policy to stimulate the economy and end a recessionary gap.

False - Classical economists believe that time lags, crowding out, and the households' responses to temporary policy changes will limit the effectiveness of fiscal policy.

True or false. Keynesian economists advocate using fiscal policy to offset any shift in aggregate demand that will cause equilibrium income to deviate from full employment income.

False - Keynesian economists advocate using policy to offset shifts that have substantial and prolonged effects on output, employment and prices.

True or false. In the US, national level political elections are infrequent and campaigns are brief.

False - all members of the House of Representatives and one third of the Senate are elected every 2 years, and the presidents are elected every 4 years, so the next election is never very far from the mind of anyone in Congress or the White House.

True or false. The persistence of deficits during expansionary phases of the business cycle is due to steadily growing defense spending.

False - deficits persist even during the expansionary phase of the business cycle due to political difficulties in cutting government spending.

True or false. Discretionary fiscal policy makes an economy more stable when there are lengthy policy lags.

False - discretionary fiscal policy combined with lags could actually make an economy less stable.

True or false. When the economy is doing well and income and output are rising at a healthy rate, transfer payments for food stamps, unemployment compensation, and social security are likely to rise.

False - fewer people will be eligible for these programs when the economy is healthy, so these payments are likely to fall.

True or false. An equal increase in government spending and taxes will have no effect on equilibrium income.

False - for example, if government spending and taxes are both increased by $20 billion, equilibrium income will increase by $20 billion.

True or false. To stabilize the economy, fiscal policy should be used to reduce spending during recessions and increase spending during inflationary periods.

False - stabilizing the economy means using expansionary policy when spending is too low and using contractionary policy when spending is too strong.

True or false. If consumers fail to respond to a temporary increase in disposable income by spending a large fraction of it, then fiscal policy will have more of an effect on output.

False - the size of multiplier effect depends on the amount of new spending caused by policy. Failure to respond means consumers are not spending in response to the policy, so it will have little or no effect.

True or false. If the economy achieves full employment at an income level of $15 trillion, and equilibrium income is currently $14.9 trillion, Keynesian economists recommend using fiscal policy to reduce equilibrium income.

False - the target income level is $15 trillion, where the economy reaches full employment.

True or false. Because economic conditions can influence political outcomes, economists are certain that politicians are able to create a political business cycle for their own benefit.

False - thus far, no economist has been able to show that politicians are actually able to create a political business cycle for their own benefit.

The Keynesian consumption function was first modified by _____ to account for differences in spending patterns that occur over the life cycle. These ideas were further developed by _____, who hypothesized that current consumption depends on past income and expected future income and not current income alone.

Franco Modigliani; Milton Friedman

Which of the following is not an automatic stabilizer?

Minimum wage

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Following the Keynesian economist's advice, Macroland's government is strongly considering a temporary decrease in taxes. The Classical economists disagree, explaining that since the decrease is temporary, households will not respond as hoped. What theory is being described by the Classical economists?

Permanent income

The 1964 and 1981 income tax cuts, which were enacted as permanent changes, appear to have had more effect on income and consumption than the 1968 temporary surcharge or the 1975 one time tax rebate. What is the most probable explanation for this?

Permanent tax cuts increase permanent income, which in turn increases current consumption.

Which proposed tax cut is likely to have the largest effect on output, according to the permanent income hypothesis?

Permanently reducing tax rates at all income levels

Based on the chart below, what is the income tax? Lopez: Taxable Income: $50,000; Tax Payment Due: $6,000 Gonzales: TI: $100,000; TPD: $10,000 Martinez: TI: $200,000; TPD: $16,000

Regressive

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Macroland's main source of revenue is from sales taxes. What type of taxation is this?

Regressive

Which category of transfer programs is least likely to change in response to changing economic conditions?

Social Security Survivor's benefits

True or false. According to Friedman's permanent income hypothesis, a 22 year old who is about to graduate from college will likely spend more than a 22 year old with very little education or job experience.

True

True or false. According to Keynesian theory, fiscal policy works by shifting the aggregate demand curve to either increase output and employment or reduce the price level.

True

True or false. According to the Keynesian model, the economy varies from the goal of full employment when aggregate expenditure is too weak.

True

True or false. According to the Keynesian model, there is sometimes a conflict between actions that are in the social interest and actions that are in a person's self interest.

True

True or false. Congressional legislation over the years, much of it enacted during the Great Depression, has created a system of tax collections and transfer payments that change automatically in response to changes in national income.

True

True or false. If the economy is below the full employment level of output, then an increase in government spending can bring the economy to the full employment level of output.

True

True or false. The Bush and Clinton tax increases in 1990 and 1993 were both intended primarily to control the deficit rather than to influence the level of output.

True

True or false. The three fiscal policy lags are the recognition lag, the implementation lag and the impact lag.

True

Which statement about the US political system is false?

US Senators are all elected every 4 years

The graphs demonstrate that expansionary fiscal policy causes equilibrium income (Y) to change from

Y1 to Y3

According to Franco Modigliani, which groups are most likely to engage in dissaving?

Young families and retired indivduals

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Using the aggregate demand and aggregate supply model, the Keynesian economist shows that if Macroland uses fiscal policy to stimulate the economy, the

aggregate demand will increase.

Fiscal policy is most effective when

a tax cut has a large effect on consumer spending.

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Previously, Macroland had decided on a policy involving unemployment benefits in which a worker who loses their job can receive the benefits for 6 months. This is an example of _____ policy.

automatic stabilizer

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Previously determined policies that will stabilize the economy, but do not need political action when the economy enters a recession or overheats, are called

automatic stabilizers

Fiscal policy refers to

changes in government spending or taxes to influence employment, inflation and economic growth.

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. Fiscal policy is

changes in taxes and government spending.

Based on the Keynesian model, policymakers are able to use _____ fiscal policy to reduce inflation and _____ fiscal policy to reduce unemployment. Used correctly, active fiscal policy should _____ the ups and downs of the business cycle.

contractionary; expansionary; decrease

The best example of a contractionary fiscal policy, designed to decrease aggregate spending, is

decreased spending on national defense and elimination of tax loopholes.

A decrease in government spending shifts the AE function _____, which shifts the AD function _____.

downward; downward

According to the political business cycle theory, when inflation is not a problem, a politician seeking reelection is likely to pursue

expansionary fiscal policy prior to the election, so voters will be satisfied with the state of the economy.

When the economy is booming, income is rising

faster than normal, so tax revenues are likely to be higher than anticipated.

Discretionary fiscal policy

has primarily supply side effects but can affect aggregate demand as well through the structure of tax changes or the composition of spending changes.

According to economist Douglas A. Hibbs Jr. economic conditions at the time of an election

have a definite effect on the success or failure of the incumbent party.

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. A progressive tax has the percentage of a person's income paid in taxes _____ as their income increases.

increase

The downward shift of the AE function from AE2 to AE3 is the result of a(n) _____ in the price level.

increase

The initial shift in the aggregate expenditure function from AE1 to AE2 is a result of a(n) _____ in government spending equal to $10 billion.

increase

Because of the multiplier process, if a tax cut causes consumption spending to initially rise by $100, the resulting change in income is likely to be

larger than $100, as spending by one person creates additional income for another person.

Based on the information presented below, the income tax is Lopez: Taxable income: $50,000; Tax Payment Due: $5,000 Gonzales: TI: $100,000; TPD: $10,000 Martinez: TI: $200,000; TPD: $24,000

progressive

The length of time needed to become aware of an economic problem is called the _____ lag. The time it takes after a problem is recognized to choose and enact a fiscal policy in response is the _____ lag. The _____ lag is the time that lapses between the implementation of a fiscal policy and its full effect on economic activity.

recognition; implementation; impact

One of the limitations of discretionary fiscal policy is

time lags.

Macroland has entered a recession and the government has asked two economists to analyze the situation and present possible solutions. One of the economists is a Keynesian economist and the other is a Classical economist. The formula for the spending multiplier is

{1/(1-MPC)}