Chapter 10 Macro

A change in net taxes

also affects real GDP demanded, but the effect is less direct on income and output than an equivalent change in government spending (purchases)

expansionary fiscal policy used to

close a contractionary gap

contractionary fiscal policy used to

close a expansionary gap

As increase in net taxes, other things constant, reduces disposable income at each level of real GDP;

consumption decreases (aggregate demand decreases)

One strength of the use of discretionary fiscal policy is the timing lags.

false

Which of the following is an example of contractionary fiscal policy?

reducing military spending

Automatic stabilizers are designed so that as income falls:

spending does not fall as much as income.

Suppose that government spending decreases by $200 billion and that the marginal propensity to consume equals 0.80. The equilibrium level of real GDP will decrease by

$1,000 billion

When the economy is growing

, tax revenues rise (because of progressive taxation) and transfer payment fall as fewer people require income assistance. These effects temper the increase in economic output

discretionary fiscal policy requires

-Requires ongoing congressional decisions -President Bush's tax cuts

FISCAL POLICY AND AGGREGATE SUPPLY

-They are designed to shift the long-run aggregate supply curve to the right. -They require more time to work than demand-side policies.

Investment can be increased by:

-investment tax credits. -more-rapid depreciation schedules for plant and equipment. -allow firms to expense capital in a shorter period, reducing tax burden -repealing unnecessary regulation. -government grants for research.

If the marginal propensity to consume is 3/4, the simple multiplier is

4

The change in real GDP can be determined as

=change in net taxes(-mpc/1-mpc)

Net taxes =

taxes - transfer payments

(Figure: Effects of Policy Shifts) If government spending increases, shifting aggregate demand from _____ to _____, aggregate output will increase from _____ to _____.

AD0; AD1; Q0; Q

THE LAFFER CURVE

ARTHUR LAFFER SUGGESTED THAT REDUCING TAX RATES COULD LEAD TO INCREASED TAX REVENUES.

contractionary fiscal policy aimed at

Aimed at decreasing Aggregate Demand (shift to the left) in order to return economy to full employment.

Government Purchases Multiplier

As long as consumption is the only spending component that varies with income, the multiplier for a change in government purchases, other things constant, equals 1/1-MPC (simple spending multiplier

FISCAL POLICY IS OFTEN FINANCED BY DEFICITS

BECAUSE POLICYMAKERS FIND IT DIFFICULT TO RAISE TAXES OR REDUCE SPENDING

Aggregate demand =

C + I + G + NX

Thus, we can say that for a given price level, and assuming that consumption varies with income change of real GDP is equal too

the change in G(1/1-MPC)

discretionary fiscal policy

the deliberate manipulation of government purchases, taxation, and transfer payments to promote macroeconomic goals, such as full employment, price stability, and economic growth

Fiscal Policy and Aggregate Demand

Demand-side fiscal policy involves using government spending, taxes and transfers payments to change aggregate demand and equilibrium output and price level in the economy.

Contractionary fiscal policy involves:

Government spending decrease, aggregate demand decrease Taxes increase, consumption decrease, aggregate demand decrease Transfer payments decrease, consumption decrease, aggregate demand decrease

All of the following are tools of fiscal policy except one. Which is the exception?

Interest rates

recognition lag

It takes time to recognize trends in the data.

The goal of supply-side fiscal policy is

to induce growth, reduce unemployment, and stabilize prices.

Expansion fiscal policy is effective

when an economy is below long-run equilibrium -But once long-run output is achieved, expansionary fiscal policy leads to demand-pull inflation

information lag

Most data that policymakers need are not available until at least one quarter after the fact.

implementation lag

Once a policy becomes law, it takes time to plan, budget, and implement the new program.

decision lag

Policies must be debated and passed in Congress and signed by the president.

automatic stabilizers

TAX REVENUES AND TRANSFER PAYMENTS AUTOMATICALLY ADJUST TO ECONOMIC FLUCTUATIONS WITHOUT ACTION BY CONGRESS.

(Figure: Laffer Curve 3) A supply-side economist is advocating reducing income tax rates. She is probably assuming that the economy is at point _____ in the graph.

a

When the MPC is .75, a decrease in net taxes of $100 billion will increase the equilibrium level of real GDP by

$300 billion

Specifically A decrease in net taxes, other things constant, increases disposable income at each level of real GDP;

consumptions increases (aggregate demand increases)

expansionary fiscal policy aimed at

increasing Aggregate Demand (shift to the right) in order to return economy to full employment.

expansionary fiscal policy

involves: -Government spending increase -Taxes decrease -Transfer payments increase

tools of discretionary fiscal policy

•Government Purchases •Taxes •Transfer Payments

Simple Tax Multiplier

The effect of a change in net taxes on real GDP demanded equals the resulting shift in the consumption function times the simple spending multiplier: -MPC/(1-MPC)

(Figure: Determining Fiscal Policy) The best discretionary fiscal policy option is:

expansionary fiscal policy that leads to full employment.