ECO 202 Chapter 16

Increased government debt can lead to higher interest rates​ and, as a​ result, crowding out of private investment spending. In terms of borrowing​ (debt-spending), what will offset the effect of crowding out in the long run so that government debt poses less of a problem to the​ economy?

- debt spending on education -debt spending on highways and ports -debt spending on research and development

Problem: Policy: Actions: Result: Recession Expan. inc gov spend Real GDP or ______ taxes & price_____ Rising Contract. _____________ spend Real GDP Inflation or inc taxes $ price ___

-decrease, rise -decrease govt spending, fall

Which of the following are categories of federal government​ expenditures?

-interest on the national debt -grants to state and local govts -transfer payments

Suppose the government increases expenditures by ​$120 billion and the marginal propensity to consume is 0.90. By how will equilibrium GDP​ change? The change in equilibrium GDP​ is: ​$_________

1200.0 billion

Which of the following is an example of an expansionary fiscal​ policy?

A decrease in taxes

The graph to the right illustrates the static​ AD-AS model. Suppose the economy is initially in​ long-run equilibrium at point A. The government decides to decrease government spending. In the​ short-run, this contractionary fiscal policy will​ cause:

A shift from AD 2 to AD 1 and a movement to point​ D, with a lower price level and lower output.

In the long​ run, government tax policy can affect private investment which impacts the production function and factors of production. In other​ words, aggregate supply may be impacted by different types of taxes the government can use. Which of the following is not true in terms of potential long run impacts of tax​ policies?

A tax rebate given one year will cause people to have more money and therefore they will spend more which will cause an increase in aggregate supply.

Which of the following is not a correct comparison between an expansionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply​ model?

A. If the economy is below full​ employment, expansionary fiscal policy will cause an increase in the price level in both models. B. In the dynamic​ model, expansionary policy would be used when demand does not grow​ sufficiently; in the basic​ model, expansionary policy would be used when demand falls. C. The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static.

The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model What would be the federal​ government's reaction if actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS 06​? That​ is, what step can we expect the federal government to take to control inflation in the second​ period?

A. Increase taxes on businesses B. Contractionary policy C. Decreases government spending on goods and services

Suppose that at the same time Congress and the president pursue an expansionary fiscal​ policy, the Federal Reserve pursues an expansionary monetary policy. How might an expansionary monetary policy affect the extent of crowding out in the short​ run?

An expansionary monetary policy would decrease interest rates and thus reduce the extent of crowding out.

What is a contractionary fiscal​ policy?

Contractionary fiscal policy includes decreasing government spending and increasing taxes to decrease aggregate demand.

What is meant by crowding​ out?

Crowding out is a decline in private expenditures as a result of increases in government purchases. Your answer is correct.B.

The figure to the right illustrates the dynamic AD-AS model Suppose the economy is in equilibrium in the first period at point​ (A). In the second​ period, the economy reaches point​ (B). We would expect the federal government to pursue what type of policy in order to move AD 2 to AD Subscript 2 comma policy and reach equilibrium​ (point C) in the second​ period? If the federal​ government's policy is​ successful, what is the effect on the following macroeconomic​ indicators? Actual real​ GDP: Potential real​ GDP: Price​ level: Unemployment:

Expansionary fiscal policy -increases -does not change -increases -decreases

What is an expansionary fiscal​ policy?

Expansionary fiscal policy includes increasing government spending and decreasing taxes to increase aggregate demand.

The multiplier effect is only a consideration for increases in government purchases.

False

What is fiscal​ policy?

Fiscal policy can be described as changes in interest rates to achieve macroeconomic policy objectives.

Suppose that the economy is currently at potential​ GDP, and the federal budget is balanced. If the economy moves into​ recession, what will happen to the federal​ budget?

If the budget is balanced at potential GDP and the economy moves into​ recession, then there will be a budget deficit as government expenditures increase and tax revenues decrease.

Which of the following best describes the difference between crowding out in the short run and in the long​ run?

In the short​ run, an increase in government purchases may not fully crowd out private expenditures due to the stimulative effect of an increase in government purchases on aggregate demand. In the long​ run, most economists believe that a permanent increase in government purchases will result in complete crowding out of private expenditures.

What changes should they make if they decide a contractionary fiscal policy is​ necessary?

In this​ case, Congress and the president should enact policies that decrease government spending and increase taxes. Your answer is correct.D.

If Congress and the president decide an expansionary fiscal policy is​ necessary, what changes should they make in government spending or​ taxes?

In this​ case, Congress and the president should enact policies that increase government spending and decrease taxes.

The figure to the right illustrates the dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point​ (A). In the second​ period, the economy reaches point​ (B). What policy would the federal government likely pursue in order to move AD 2 to AD Subscript 2 comma policy and reach equilibrium​ (point C) in the second​ period?

Increase government spending

The graph to the right shows a situation in which the economy was in equilibrium at potential GDP​ (at point​ A) when the demand for housing sharply declined. What actions can Congress and the president take to move the economy back to potential​ GDP?

Increase govt spending or decrease taxes

Which can be changed more​ quickly: monetary policy or fiscal​ policy?

Monetary policy can be changed more quickly than fiscal policy. Monetary policy can be changed at any of the FOMC meetings and the smaller number of individuals involved makes it easier to change policy.

What is the cyclically adjusted budget deficit or​ surplus?

The cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal​ government's budget if the economy were at potential GDP.

Who is responsible for fiscal​ policy?

The federal government controls fiscal policy.

If the​ short-run aggregate supply curve​ (SRAS) were a horizontal​ line, what would be the impact on the size of the government purchases and tax multipliers ?

The impact of the multiplier would be larger if the SRAS curve is horizontal.

Why might cutting government spending as a fiscal policy be a more difficult policy than the use of monetary policy to slow down an economy experiencing​ inflation?

The legislative process experiences longer delays than monetary policy.

When is it considered​ "good policy" for the government to run a budget​ deficit?

When borrowing is used for​ long-lived capital goods.

Does government spending ever reduce private​ spending?

Yes, due to crowding out

If the government cuts taxes in order to increase aggregate​ demand, the action is called

a discretionary fiscal policy.

President Trump was assuming that in​ 2017, the economy was

able to create more jobs and expand without increasing the inflation rate.

When actual GDP is below potential GDP the budget deficit increases because​ of:

an increase in transfer payments and a decrease in tax revenues.

Changes in taxes and spending that happen without actions by the government are called

automatic stabilizers

______________are spending by the government on​ goods, services, and factors of production. ______________ represent total government spending including​ goods, services, grants to state and local​ governments, and transfer payments. Since the​ 1950s, total government​ expenditures, as a percentage of​ GDP, have __________________ and total government​ purchases, as a percentage of​ GDP, have ___________ .

government purchases, government expenditures, increased, decreased

Assume the tax multiplier is estimated to be 1.4 and the aggregate supply curve has its usual upward slope. Suppose the government lowers taxes by ​$108 million. Aggregate demand will __________ by ​$______ million. ​(Enter your response rounded to one decimal​ place.)

increase, 151.2

Suppose the government increases expenditures while holding taxes the same. This will _______ deficits or _________ surpluses.

increase, decrease

The federal government would not want to increase its​ spending, even if the result were to increase real GDP and employment in the short​ run, if

it would lead to a greater federal deficit and an increase in the national debt.

The federal​ government's day-to-day activities include running federal agencies like the Environmental Protection​ Agency, the​ FBI, the National Park​ Service, and the Immigration and Customs Enforcement. Spending on these types of activities make up

less than 10 percent of federal government expenditures.

As a result of crowding out in the short​ run, the effect on real GDP of an increase in government spending is often

less than the increase in government spending.

In​ 2017, in proposing a​ $1 trillion increase in government spending on​ infrastructure, President Trump argued that the spending would increase total employment in the United States. ​ Source: Ted Mann and Michael C.​ Bender, "President Trump to Launch Push for Infrastructure​ Investment," Wall Street Journal​, June​ 4, 2017. In the short​ run, increases in federal spending will increase real GDP and employment if

the economy is producing at less than its potential output and has some cyclical unemployment.

The major cause of these trends is

there has been a major increase in the amount of transfer payments the government makes through programs such as Social Security and unemployment insurance.

The largest and fastest-growing category of federal government expenditures is

transfer payments

When the economy is experiencing a recession automatic stabilizers will​ cause:

transfer payments to increase and tax revenues to decrease.