Macro Chapter 8, 9, 10

Cyclically Balanced Budget

Balancing the budget over the course of the business cycle by restricting spending or raising taxes when the economy is booming and using these surpluses to offset the deficits during recessions

The short-run aggregate supply is upward sloping because input prices are in the short run.

Sticky

The collapse of home values in 2008 led to _____ in Americans' consumption and _____ in their saving rates.

a decrease; an increase

If a government collects $1,400 in tax revenue and spends $1,600, it has:

a deficit of $200.

Other factors of investment demand

a) Expectations (+) b) Technological Change (+) c) Operating Costs (-) d) Capital Goods on Hand (-)

The output of all the goods and services demanded in an economy at various price levels is called:

aggregate demand

According to the textbook, what brought the United States out of the Great Depression?

an increase in spending on World War II

Investment is defined as spending by:

business that adds to the productive capacity of the economy.

Suppose in 2009, country X had tax revenues of $550 billion and government expenditures of $700 billion. In addition, at the end of 2008, its national debt was $6.5 trillion. In 2009, country X had a _____ and at the end of 2008, a public debt of _____.

deficit of $150 billion; $6.65 trillion

According to public choice economists, the federal government has expanded because:

deficit spending has reduced the perceived cost of current government operations.

What type of government spending would be most effective in mitigating the crowding-out effect?

education subsidies

Economists who favor a(n) _____ approach to the federal budget believe that the first priority of policymakers should be to keep the economy at full employment with stable prices.

functional finance

If the marginal propensity to consume is 0.8, full-employment output is $14 trillion, and current output is $13.5 trillion, then investment spending must _____ to reach full-employment output.

increase by $0.1 trillion

The shift in aggregate demand depicted may be due to a(n):

increase in income taxes.

Which of the following events causes a decrease in aggregate demand?

increase in taxes

Rising productivity will increase economic growth and raise the average standard of living, shifting the _____ curve to the _____.

long-run aggregate supply; right

The idea of the spending multiplier is that:

one person's spending becomes another person's income, which stimulates more spending.

In the short run, the aggregate supply curve is _____ because input prices are _____.

positively sloped; not completely flexible

High taxes and/or heavy regulation:

raise costs of production so that the aggregate supply curve shifts to the left.

If both consumers and businesses are pessimistic about the future of the economy:

the aggregate demand curve shifts to the left.

Firms decide how much to invest by comparing the rate of return on their projects with:

the interest rate.

Which of the following items does NOT constrain the federal budget?

the mortgage interest rate

If an expansionary policy pushes output beyond the full employment level of GDP:

the short-run aggregate supply curve will shift to the left.

In the simple Keynesian model with no government and foreign sectors, suppose that initially the economy is in equilibrium at an output level of $10 trillion with a marginal propensity to consume of 0.8. If investment spending increases by $0.5 trillion, what is the new equilibrium output level?

$12.5 trillion

Investment spending is $600. If there is no government spending or net exports, the equilibrium income level is:

$4,000.

If consumption increases from $500 billion to $575 billion and income increases from $600 billion to $700 billion, the marginal propensity to save is:

0.25

If the marginal propensity to consume is 0.8, by how much will total income increase after an initial $200 is spent?

1,000

Assume that the economy is in equilibrium at $6000, and full employment is at $5000. If MPC=.5, how big is the inflationary gap?

1/ 1-MPC = 1/1-.5 = 1/.5 = 2 2(IG) = 1000 IG = 500

If MPS=0.25, by how much will total income increase after an initial $100 is spent?

1/MPS = 1/.25 = 4 4(100) = 400

Spending by federal, state, and local governments has grown from _____ of GDP in the 1930s to more than _____ today.

10%; 30%

If the marginal propensity to save is 0.2, the value of the spending multiplier will be:

5

Determinants of Aggregate Demand

A change in the aggregate price level will change the quantity of real GDP demanded along the entire demand curve Determinants of aggregate demand are factors that shift the entire aggregate demand curve a) Consumption b) Investment c) Government Spending d) Net Exports

Which of the following causes an increase in aggregate demand?

A decrease in taxes

Suppose that Japan is a nation of savers with a marginal propensity to consume of 0.6 and that the United States is a nation of spenders with a marginal propensity to consume of 0.9. Which of the following statements is correct?

A small increase in spending will have a more powerful effect in starting a recovery in the United States than in Japan.

If disposable income is $200 and consumption is $50, how much is the average propensity to save?

APS = S/Y 150/200 = .75

National Debt

Accumulation of all past debts less surpluses

Spending Withdrawals

Activities that remove income from the economy a) Savings in this model At equilibrium, spending injections equals spending withdrawals

Deficit

Amount by which annual government expenditures exceed tax revenues

Surplus:

Amount by which annual tax revenues exceed government expenditures

Paradox of Thrift:

An increase in savings leads to a reduced income due to the multiplier effect. This creates less savings.

Anne and Charlie are discussing the best possible fiscal policy to bring the country out of a recession. Charlie wants to see government reduce taxes by $100 billion. Anne prefers to see government spending increase by $100 billion. Whose proposition would have the larger total impact on aggregate demand?

Anne's, because all of the additional government spending will enter the spending stream, while part of a tax cut would be saved and not spent

Suppose the government increases aggregate demand to a level that increases GDP above its long-run equilibrium level. What sequence of events would follow?

prices rise; GDP increases; workers demand higher wages; short-run aggregate supply shifts to the left; GDP drops

Under a cyclically balanced budget, a government should _____ when the economy is growing and _____ when GDP is declining.

raise taxes; raise spending

The _____ lag is the time it takes for policymakers to confirm that the economy is trending in or out of a recession.

recognition

Assume initially the economy is at full employment. If aggregate demand increases, the aggregate price level and costs will _____, and ultimately, the short run aggregate supply curve shifts to the _____.

rise; left

In the simple Keynesian model, the economy will be in equilibrium when:

savings is equal to investment.

Discretionary Fiscal Policy

Describes the use of government taxation and spending to influence the economy. a) Taxation b) Government Spending c) Transfer Payments = money payments to individuals for items such as Social Security

Determinants of Long Run Aggregate Supply

Determinants of long run aggregate supply are factors that shift the entire long run aggregate supply curve a) Amount of capital available b) Size and quality of labor force c) Technology employed

Determinants of Short Run Aggregate Supply

Determinants of short run aggregate supply are factors that shift the entire short run aggregate supply curve a) Input prices b) Productivity c) Taxes and regulation d) Market power of firms e) Inflationary expectations

Balanced Budget Multiplier:

Equal changes in government spending and taxation lead to an equal change in income a) Balanced budget multiplier is one

Annually Balanced Budget:

Expenditures and taxes would be equal every year

Interest paid on externally held debt does not pose a burden on our economy.

False

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

False

Functional Finance

Focuses on fostering economic growth and stable prices while keeping the economy near full employment

GDP

GDP can be computed by adding up all spending or income in an economy. By the spending approach, we have GDP = Aggregate Expenditures GDP = AE = C+I+G+(X-M)

Macroeconomic Equilibrium in the Model

In this model, AE = C + I. a) Recall that at equilibrium, AE = Y b) Also, Y = C + S Equating terms, we see savings equals investment (S=I) at equilibrium

Determinates of Consumption and Saving

Income is the main determinant of consumption and saving in the model. Other factors can shift the consumption and savings schedules: a) Wealth b) Expectations c) Household Debt d) Taxes

Recessionary Gap:

Increase in aggregate spending needed (when accounting for the multiplier) to bring a depressed economy back to full employment a) Suppose full employment income is $4,400, current equilibrium income is $4,000, and the multiplier is 4. Then the recessionary gap is $100. b) Note $4,400-$4,000 = $400 is called the GDP gap

During a supply shock in the short run, the aggregate price level:

Increases

Spending Injections

Increments of spending a) Investment in this model

Fiscal Policy Timing Lags

Information Lag: Time required to acquire macroeconomic data Recognition Lag: Time required to recognize trends in the data Decision Lag: Legislative process to enact policies Implementation Lag: Time required after laws are passed to set up programs

Adding Government Spending, Taxes, Imports, and Exports

Injections: Investment (I), Government Spending (G), and Exports (X) Withdrawals: Savings (S), Taxes (T), and Imports (M) At equilibrium, I+G+X = S+T +M

Assume that the economy, as represented by the simple Keynesian model, is in equilibrium with income equal to $6 million and consumption spending equal to $5 million. Which of the following is correct?

Investment is $1 million.

Investment Demand

Investment levels depend primarily on the rate of return on capital. Interest rates are also important in determining investment a) As interest rates fall, investment rises b) Investments with a high rate of return are undertaken first.

Assume a Keynesian economy is similar has a multiplier of 4. What is the MPC equal to? The MPS?

MPS = 1/4 MPC + MPS = 1 MPC + .25 = 1 MPC = .75

Which of the following is NOT a determinate of short-run aggregate supply?

Net exports

The Spending Multiplier

New spending generates income that results in more spending and income a) Process happens until income changes by 1/(1- MPC)=1/MPS b) Multiplier = 1 / (1-MPC)

Multiplier Effect

Occurs when a dollar of spending generates many more dollars of spending in an economy

Cost-Push Inflation

Occurs when a supply shock (ex: oil shock 1973) hits the economy, reducing short-run aggregate supply, and so reducing output and increasing the price level. a) Policymakers can return the economy to full- employment by increasing aggregate demand but must deal with the result of higher prices b) An alternative is for policymakers to decrease aggregate demand which causes lower output and higher unemployment

Demand-pull inflation

Occurs when aggregate demand expands so much that equilibrium output exceeds full employment output. a) In the short run, workers incur overtime, temporary workers are added, and more shifts are employed b) Prices increase and cause higher input prices (ex: workers demand higher wages) c) This causes the SRAS curve to shift left causing an even higher price

Contractionary Fiscal Policy

Policies that decrease aggregate demand to contract output in an economy a) Decreasing government spending b) Increasing taxes When an economy is overheating, contractionary policies reduce aggregate demand, bringing back the economy to the full employment level.

Supply-Side

Policies that focus on shifting the long-run aggregate supply curve to the right a) Do not always require tradeoffs between price levels and output b) Takes longer to impact the economy By using fiscal policy directed at supply, output is expanded while keeping inflation in check.

Expansionary Fiscal Policy

Policies that increase aggregate demand to expand output in an economy a) Increasing government spending b) Decreasing taxes When the economy is below full unemployment, expansionary fiscal policy will move the economy to full employment. When the economy is at full employment , an expansionary policy raises prices without producing any long-run improvement on output.

Public Debt

Portion of the National Debt that is held by the public (i.e Treasury bills, bonds, etc.)

Externally Held Debt:

Public debt held by foreigners, including foreign industries, banks, and governments a) In a decade, foreign holdings have doubled to nearly 50% of debt held by the public

Internally Held Debt:

Public debt owned by domestic banks, corporations, mutual funds, pension plans, and individuals

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

Raising income taxes

Export Price Effect:

Rising price levels cause domestic goods to be more expensive in the global market resulting in fewer purchases by foreign consumers

The 45 degree line

Shows where spending equals income. As income rises, consumption rises but not as fast as income. When the curves cross, income equals consumption.

Mandatory Spending

Spending authorized by permanent laws that do not go through the same appropriations process as discretionary spending a) Includes Social Security, Medicare, and interest on the national debt

Investment

Spending by businesses that adds to the productive capacity of the economy. a) Investment is an important component of expenditures model b) Investment is very volatile

Multiplier Works in Both Directions

Spending increases raise equilibrium income by the increase times the multiplier Spending decreases lower equilibrium income by the decrease times the multiplier a) During a recession, a decrease in spending can cause an even larger drop in income due to the multiplier

Supply-Side Fiscal Policies

Spending on Infrastructure, Education, and Technology: Increases productivity which increases growth Decreasing Tax Rates : Provides firms incentive to expand or individuals to work more Expanding Investment and Reducing Regulations: Repeal unnecessary regulations that hamper business and add to costs

Inflationary Gap:

Spending reduction necessary (when accounting for the multiplier) to bring an overheated economy back to full employment a) Suppose full employment income is $4,400, current equilibrium income is $5,000, and the multiplier is 3. Then the inflationary gap is $200.

Automatic Stabilizers:

Tax revenues and transfer payments automatically expand or contract in ways that reduce the intensity of fluctuations without action by congress When the economy is strong, tax receipts rise and transfer payments fall (both contractionary)

Aggregate Demand

The aggregate demand curve shows the output of goods and services (real GDP) demanded at different price levels. Aggregate output increases as the aggregate price level decreases

Aggregate Supply

The aggregate supply curve shows the real GDP that firms will produce at given price levels. Two different possibilities: short run and long run

Marginal Propensity to Consume (MPC)

The change in consumption associated with a given change in income a) MPC = ∆C /∆Y

Marginal Propensity to Save (MPS)

The change in savings associated with a given change in income a) MPS = ∆S /∆Y MPC+MPS =1

The Potbelly Pothole Company is undertaking some investments in its plant. Suppose interest rates fall and new technologies increase the return on its investment. What is likely to happen?

The company's demand for investments will rise.

The loss of business investment due to government borrowing is known as:

The crowding-out effect

Saving

The difference between income and consumption. a) S = Y - C b) S+C = Y

Long Run

The long-run aggregate supply curve is vertical at full employment because the economy has reached its capacity to produce. a) All variables are adjustable in the long run b) Economy gravitates to full employment level

Discretionary Spending

The part of the budget that goes through the appropriations process of congress each year a) Includes national defense, transportation, science, environment, and income security

Average Propensity to Consume (APC)

The percentage of income that is consumed a) APC = C / Y

Average Propensity to Save (APS)

The percentage of income that is saved a) APS = S / Y APC+APS =1

Short Run

The short-run aggregate supply curve is positively sloped because many input costs are slow to change (sticky) in the short run. a) Rents or wages are examples of input costs b) Since input costs are sticky, profits rise with prices so firms supply more output in the short run

Macroeconomic Equilibrium

The short-run macroeconomic equilibrium occurs at the intersection of the short run aggregate supply and aggregate demand curves. The long-run macroeconomic equilibrium occurs at the intersection of the long run aggregate supply and aggregate demand curves.

An example of discretionary spending is:

Transportation

According to the wealth effect, as prices fall, people feel wealthier and purchase more goods and services.

True

One way to increase aggregate supply and economic growth is to repeal regulations that have more costs than benefits to businesses.

True

Public choice economists think deficit spending reduces the perceived cost of current government operations and then shifts additional costs to the next generation.

True

The 45-degree line represents the set of points where aggregate expenditures is equal to disposable income.

True

The determinants of aggregate demand include the components of GDP: consumption, investment, government spending, and net exports.

True

The long-run aggregate supply curve represents the full-employment capacity of the economy.

True

Why is the Aggregate Demand Curve Negatively Sloped?

Wealth Effect Export Price Effect Interest Rate Effect

Crowding-Out Effect:

When deficit spending requires the Government to borrow, interest rates are increases, reducing consumer spending and business investment

Interest Rate Effect:

When price levels rise, people need money for transactions. This added demand for money drives up interest rates which decreases investment spending.

Wealth Effect:

When price levels rise, the purchasing power of money saved falls

In recent years, countries such as China have been _____ U.S. debt as a way to keep their currencies from _____ against the U.S. dollar.

buying; rising

A(n) _____ in productivity and a(n) _____ in taxes will shift short-run aggregate supply to the right.

increase; decrease

Which of the following policies do supply-side economists believe is the best for increasing the standard of living?

increasing investment in capital that boosts worker productivity

Using demand-side fiscal policy to stimulate aggregate demand when the economy is at full employment will primarily result in:

inflation

The GDP gap divided by the multiplier yields the:

inflationary or recessionary gap.

Which fiscal policy time lag is caused by the fact that GDP data are not immediately available?

information lag

A shift to the _____ of the _____ curve would cause the price level and employment to decrease.

left; aggregate demand

If the amount of regulation in an economy increases, the aggregate supply curve shifts _____ and output supplied will _____.

left; decrease

Increased taxes will shift the aggregate demand curve to the _____ and _____ output demanded.

left; decrease

If aggregate expenditures equals $7,600 and aggregate income equals $8,000, businesses will produce:

less, lowering both employment and income.

The laffer curve shows that:

A high and low tax rate can produce the same tax revenues

The Multiplier

1 / (1 - MPC) = 1 / (MPS)

Which of the following is not a way the government finances its deficit.

Buying bonds from the federal reserve

Which of the following is the largest component of GDP?

Consumption

Consumption

Consumption: Spending by individuals and households on both durable goods and non-durable goods. Largest percentage of GDP.

In the diagram below, the best discretionary fiscal policy is:

Contractionary fiscal policy

Automatic stabilizers are designed so that as income falls:

spending does not fall as much as income.

In a cyclically balanced budget approach to federal finance:

surpluses from economic expansions would cancel out deficits from economic downturns.

A problem with supply-side fiscal policies is that they:

take longer to implement than demand-side fiscal policies.

Investment spending:

tends to be volatile.

Which of the following groups must agree in order to implement fiscal policy?

the Senate, House of Representatives, and executive branch