Chapter 11 - borrowed

From a macro perspective, the federal budget is a tool that can shift aggregate demand and thereby alter macroeconomic outcomes.

True

The steps required to formulate fiscal policy are straightforward: • Specify the amount of the desired AD shift (AD excess or AD shortfall). • Select the policy tools needed to induce the desired shift.

True

The general formula for computing the desired stimulus (increase in government spending) is the AD shortfall divided by the multiplier, therefore $500 divided by 4 is equal to $125.

$1,000 billion. *The value of the multiplier is equal to 1 divided by 1 minus the marginal propensity to consume. If the MPC is .8, the multiplier is 5. The amount that AD increases from fiscal stimulus is equal to the multiplier times the new spending injection or fiscal stimulus. So if the government increases spending by $200 billion, the total change in spending will by $1000 billion (5 × 200).

In order to obtain a cumulative reduction in spending, to eliminate excess AD, policy makers have determined the desired fiscal restraint is $75 billion. If the marginal propensity to consume is 0.75 what would the desired tax hike, measured in billions of dollars, need to be to ensure excess AD is eliminated?

$100

If the multiplier is 4.4, then a new spending injection of $500,000,000 will lead to a total change in spending of:

$2,200,000,000

Suppose that policy makers have conducted a study and found that in order to close a particular AD shortfall, the desired fiscal stimulus is $225 billion. If the marginal propensity to consume (MPC) is 0.9 what would the desired tax cut, measured in billions of dollars, need to be to ensure the desired fiscal stimulus is achieved?

$250

To eliminate an AD shortfall of $120 billion when the economy has an MPC of 0.75, the government should decrease taxes by:

$40 billion. *The desired fiscal stimulus is equal to the AD shortfall divided by the multiplier. ($120/4 = $30) The general formula for computing the desired tax cut is the desired fiscal stimulus divided by the MPC. ($30/.75 = $40) Therefore the government should decrease taxes by $40 billion.

Which of the following fiscal policies would cause a decrease in aggregate expenditures?

An increase in taxes and a decrease in government spending *The fiscal policies available to the federal government for restraining aggregate demand are to reduce government spending, increase taxes, or decrease transfer payments.

The balanced budget multiplier is equal to:

1 *Changes in government spending are more powerful than changes in taxes or transfers. This implies that an increase in government spending seemingly "offset" with an equal rise in taxes will actually increase aggregate demand. The balanced budget multiplier is equal to 1.

If policy makers determine there is an AD excess of $125 billion and the multiplier is estimated to be 6.0, then the desired fiscal restraint, measured in billions of dollars, is:

20.8

If aggregate demand increases by the amount of the recessionary GDP gap and aggregate supply is upward sloping:

A recessionary GDP gap will still exist. *If aggregate demand increased by the amount of the recessionary GDP gap, the economy would fall short of full employment. Some of the increased demand pushes up prices instead of output. To reach full-employment equilibrium the AD curve must shift by the amount of the entire AD shortfall.

What happens to aggregate demand when government spending and the taxes to pay for it both rise by the same amount?

Aggregate demand rises by the amount of the government spending *Changes in government spending are more powerful than changes in taxes or transfers. This implies that an increase in government spending seemingly "offset" with an equal rise in taxes will actually increase aggregate demand.

According to Keynes, the level of economic activity is predominantly determined by the level of:

Aggregate demand. *From a Keynesian perspective, too little aggregate demand causes unemployment and too much aggregate demand causes inflation.

The crowding out effect refers to a decrease in:

Consumption or investment as a result of an increase in government borrowing. *If the government raised taxes for this purpose, the fiscal stimulus would be largely offset by resultant declines in consumption and investment. If, instead, the government borrows the money from the private sector, less credit may be available to finance consumption and investment, again creating an offsetting reduction in private demand. In either case, government spending may "crowd out" some private expenditure. If this happens, some of the intended fiscal stimulus may be offset by the crowding out of private expenditure.

A tax cut:

Contains less fiscal stimulus than an increase in government spending of the same size. *Only part of a tax cut is used to increase consumption; the remainder is saved. Accordingly, the initial spending injection is less than the tax cut. This makes tax cuts less stimulating than government purchases of the same size. Multiple

The impact of fiscal stimulus on aggregate demand includes the new government spending, but not all subsequent increases in consumer spending are triggered by multiplier effects.

FALSE

The effect of a tax cut that increases disposable incomes is to decrease consumer spending.

False

The use of government taxes and spending to alter economic outcomes is known as:

Fiscal policy. *Fiscal policy is the use of government taxes and spending to alter macroeconomic outcomes.

Tax hikes or spending cuts intended to reduce (shift) aggregate demand are known as:

Fiscal restraints.

A tax cut intended to increase aggregate demand is an example of:

Fiscal stimulus. *The fiscal policies available to the federal government for increasing aggregate demand are to increase government spending, decrease taxes, or increase transfer payments.

From a Keynesian perspective, the way out of recession is to:

Get consumers to spend more on goods and services. *From a Keynesian perspective, the way out of recession is to increase spending on goods and services.

If the multiplier is 4 and a change in government spending leads to a $500 million decrease in aggregate demand, we can conclude that:

Government spending decreased by $125 million. *The general formula for computing the desired stimulus (increase in government spending) is the AD shortfall divided by the multiplier, therefore $500 divided by 4 is equal to $125.

Payments to individuals for which no current goods or services are exchanged are known as:

Income transfers. *Income transfers are payments to individuals for which no current goods or services are exchanged, such as Social Security, welfare, and unemployment benefits

Assume the MPC is 0.75, taxes increase by $100 billion, and government spending increases by $100 billion. Aggregate demand will:

Increase by $100 billion. *The balanced budget multiplier is equal to 1. In this case, a $100 billion increase in government expenditures combined with an equivalent increase in taxes increases aggregate demand by $100 billion.

Assume the MPC is 0.75. To eliminate an AD shortfall of $200 billion, the government should:

Increase spending by $50 billion. *The general formula for computing the desired stimulus (increase in government spending) is the AD shortfall divided by the multiplier, therefore $200 billion divided by 4 (1/(1 - .75)) is equal to $50 billion. A decrease in spending or an increase in taxes would cause the shortfall to increase.

Which of the following is a fiscal policy tool used to stimulate the economy?

Increased government purchases *The fiscal policies available to the federal government for increasing aggregate demand are to increase government spending, decrease taxes, or increase transfer payments. Using interest rates to alter the macroeconomy is a monetary policy tool.

Ceteris paribus, which of the following is true about the concept of crowding out?

It reduces the private sector's ability to raise the level of output *If the government raised taxes for this purpose, the fiscal stimulus would be largely offset by resultant declines in consumption and investment. If, instead, the government borrows the money from the private sector, less credit may be available to finance consumption and investment, again creating an offsetting reduction in private demand. In either case, government spending may "crowd out" some private expenditure. If this happens, some of the intended fiscal stimulus may be offset by the crowding out of private expenditure.

The total change in aggregate spending generated by increased government spending depends on the:

Marginal propensity to consume. *How much the aggregate spending changes for each government dollar spent depends on the value of the multiplier which is equal to 1 divided by 1 minus the marginal propensity to consume.

According to Figure 11.2, a shift from AD1 to AD2 will:

Move equilibrium to point Y because of an increase in the price level. *If aggregate demand increased by the amount of the recessionary GDP gap, we would get a shift from AD1 to AD2. The new equilibrium would occur at point Y, leaving the economy short of full employment (QF). Some of the increased demand pushes up prices instead of output.

The following type of government spending would be considered a government purchase:

Purchases to improve the education system

Which of the following is a policy option to eliminate an AD shortfall?

Reduce taxes *When the economy is in a slump, the government can stimulate the economy with more government purchases, tax cuts, or an increase in transfer payments.

A shift from AD1 to AD2 in Figure 11.2 will:

Reduce, but not close, the GDP gap. *If aggregate demand increased by the amount of the recessionary GDP gap, we would get a shift from AD1 to AD2. The new equilibrium would occur at point Y which is still left of point Z, leaving the economy closer but still short of full employment (QF). Some of the increased demand pushes up prices instead of output.

Which of the following explains why the government should not increase spending by the entire amount of the AD shortfall to move the economy to full employment?

The multiplier process will contribute to an additional increase in aggregate demand which will cause an inflationary gap. *It is not necessary for the government to increase spending by the entire amount of the AD shortfall. Were government spending to increase by the amount of the shortfall, the AD curve would actually shift to an equilibrium level beyond full employment equilibrium. The economy would quickly move from a situation of inadequate aggregate demand to a situation of excessive aggregate demand.

Which of the following is true when the government attempts to move the economy to full employment by increasing spending?

The total change in spending includes both the new government spending and the subsequent increases in consumer spending. *Fiscal stimulus such as increased government spending will set off the multiplier process. As a result of this, aggregate demand will increase (shift) in two distinct steps: (1) the initial fiscal stimulus and (2) induced changes in consumption.