Economics Unit 5 Test

What is M2 money supply?

A measure of money supply that consists of M1 plus savings deposits and certain time deposits.

What is the M1 money supply?

A measure of money supply that essentially consists of cash and checkable deposits.

What is the national debt?

Annual deficits contribute to the __________ ____________, which is the total amount of money that the government owes.

How does the Progressive Income Taxes work?

As income increases, so do the tax rate and the amount of taxes paid. The progressive nature of the income tax allows it to act as an automatic stabilizer to the economy without additional government action.

What is an example of a regressive tax structure?

The Jones family earns $20,000 and spends $15,000 on taxable goods, they pay $750 in sales taxes (5 percent of $15,000), or 3.75 percent of their income. The Smith family earns $50,000 and spends $25,000 on taxable goods, they pay $1,250 in sales tax (5 percent of $25,000), or 2.5 percent of their income. Property taxes are also considered this type of tax.

What does the Office of Management and Budget (OMB) do?

The President's budget is prepared by this office and takes into account estimated tax receipts and requests by all federal departments and agencies.

Who appoints Board of Governors and Chairman of the Fed?

The President. The Bd of Governors appointed by the President are approved by the Senate.

What tools do the federal government and Federal Reserve use to effect the economy?

Fed government - raising or decreasing taxes and increasing or reducing spending; Fed Reserves - adjusting the discount rate, adjusting the reserve requirement rate, and open market operations

How are fiscal policy and monetary policy similar and different?

Fiscal policy is the federal government's use of taxes and government spending to affect the economy. It has one of two goals: to decrease unemployment or to fight inflation. Monetary policy includes all the Federal Reserve actions that change the money supply in order to influence the economy. Its purpose is to curb inflation or to reduce economic stagnation or recession.

Explain Policy Lags as a limitation of fiscal policy

Fiscal policy lags behind the economic conditions it is designed to address. 1. This situation is often related to identifying the problem and getting Congress to move on the issue. Months of debate may precede policy change. 2. The lag also may be related to how quickly the change in policy takes effect.

What is an example of discretionary spending?

For example, the federal government can decide to fund or not fund highway construction or maintenance of national parks. • Defense • interstate highway system and transportation programs; • natural resources and the environment; • education, most notably college tuition assistance; • science, space, technology, and other research programs; • justice administration

What is an example of mandatory spending?

For example, the law requires that the government spend money to fund programs such as Social Security, Medicare, Medicaid, Food Stamp, and Veteran's benefits.

Approximate breakdown of US deficit (foreign countries, US investors, Fed Reserve, trust funds)

Foreign investors = 44.6% U.S. investors = 55.4% Fed Reserve = 16%. Trust Funds = pension funds?

Who can hold these government bonds?

Individuals, state and local governments, insurance companies, pension funds, financial institutions, the Federal Reserve banks, and foreign investors hold these bonds.

How do Treasury bonds work or why invest in them?

Interest is paid on all the government bonds, with higher interest rates sometimes being paid on instruments with longer maturity dates.

What is a government savings bond? Length? How does it work?

It is a gov't security. Savings bonds mature in 20 years and are available in both small and large denominations—from $25 up to $10,000.

Which tax funds local education?

Local Property taxes

State vs local budget- which spends larger % on elementary/high school?

Local budget - About 46 percent of local government spending goes to elementary/high school education.

What are the 2 major indicators of the money supply?

M1 and M2

Explain Regional Differences as a limitation of fiscal policy

Related to geography. Not every state or region of the country may be experiencing the same economic issues. For example, the Gulf Coast region may be recovering from the economic effects of hurricane damage. At the same time, the West Coast may be experiencing a high tech boom that is causing inflation. The Gulf Coast might benefit from expansionary policies, while contractionary policies might be best for the West Coast. In such circumstances, broad fiscal-policy solutions may not be appropriate.

Understand progressive tax brackets

See book page 413.

How can the monetary and fiscal policy coordinate to improve the economy, or work against each other?

See figures 16.2, 16.3 for coordination; See figure 16.4 for working against each other

What are the Functions of the Federal Reserve?

Services for banks and for federal government Banks 1) provide check clearing and other services that facilitate the transfer of funds, 2) lending money, and 3) regulating and supervising banking activity. Fed Gov't 1) Paying government bills, 2) Selling government securities 3) Distributing currency

What are some examples of entitlement programs?

Social Security and Medicare provide payments to anyone who is eligible based on age or disability.

Explain political issues as a limitation of fiscal policy

Sometimes, political considerations, most notably enhancing the chances of reelection, may influence the kind of fiscal policy that a government follows. The Council of Economic Advisers is a three-member group that advises the President on fiscal policy and other economic issues. Because of political pressures, however, the President may not always follow their advice. Even if the President does accept the council's guidance, members of Congress may not agree with proposed policies. This is an important issue since the House of Representatives is where all tax bills originate.

State vs local budget- which spends larger % on colleges?

States. Education is a major expense for the states, which not only support community colleges and state university systems but also provide assistance to local school districts.

Describe the role of the federal government and Federal Reserve in our economy.

The goals of both are to stabilize the economy by easing the effects of recession and controlling inflation.

When is a contractionary fiscal policy implemented?

Used to slow the economy down in order to slow inflation and to slow the economy when in a period of too-rapid expansion

Difference between W-2 and 1099

W-2 form: shows income earned during the year, and how much taxes paid by withholding; issued by employer 1099 form: shows the interest or dividend earned during the year; issued by bank or financial institution

When is an expansionary fiscal policy implemented?

When the economy slows or when the economy is weak

What is an example of a flat/proportional tax structure?

a 15% tax on income regardless of a person's income; An individual who earns $20,000 pays $3,000 in taxes, and an individual who earns $50,000 pays $7,500 in taxes.

Aggregate Demand

the amount of goods and services in the economy that will be purchased at all possible price levels.

What is expansionary fiscal policy?

the government may use this fiscal policy as a plan to increase aggregate demand and stimulate a weak economy to grow. Fiscal policy is described as countercyclical because the goal is to smooth out the peaks and troughs of the business cycle.

What is a capital budget?

a budget that highlights a firm's spending plans for major asset purchases that often require large sums of money; is a plan for major expenses or investments; provide funds for large construction and maintenance projects on state buildings, roads, and bridges, as well as for land acquisition for state construction needs or state parks. Usually funded through borrowing

What is an operating budget?

a financial plan for day-to-day activities of operation (expenses); generally covers expenses that occur each year, such as salaries for state government employees, payments for health and welfare benefits, and funds for education systems. Subject to balanced-budget requirements

What is an example of a progressive tax structure?

a person's income is $40,000, the person pays 10% tax on the first $10,000, then 15% tax on $20,000, then 25% on remaining $10,000; the total taxes the person pays is $6,500

What is contractionary fiscal policy?

a plan to reduce aggregate demand and slow the economy

Corporate income tax

a tax paid by a corporation based on their profits

What does it mean by an entitlement program?

are social welfare programs with specific requirements

Demand-side fiscal policy ("Keynesian economics")

goal is to increase aggregate demand and lower unemployment during a recession, active role of government, government spending, deficit spending. Keynesian Economics = the idea that in times of recession aggregate demand needs to be stimulated by government action.

Supply-side fiscal policy ("trickle-down" or Reaganomics")

goal is to increase aggregate supply, lower taxes/government spending/regulation, incentive producers to work/save/invest more. is designed to provide incentives to producers to increase aggregate supply.

What are Treasury Notes (T Notes)? Length?

gov't security; they are bonds that mature between 2 and 10 years.

What are Treasury bonds (T Bonds)? Length?

gov't security; they are issued for 30 years

What are Treasure Bills (T Bills)? Length?

gov't security; they are short-term bonds that mature in less than one year.

Structure of the Fed

has both a national and a regional structure; Made up of the Bd of Governors and 12 District Banks and Member Banks

expansionary monetary policy

is a plan to increase the amount of money in circulation; Federal Reserve system actions to increase the money supply, lower interest rates, and expand real GDP; AKA an easy-money policy.

contractionary monetary policy

is a plan to reduce the amount of money in circulation; the Federal Reserve's policy of increasing interest rates to reduce inflation. AKA a Tight-money policy

Demand-side fiscal policy

is a plan to stimulate aggregate demand

Excise tax

is a tax on the production or sale of a specific good or service, such as gas or telephone service

Some states have 0 income tax. T or F

True; Alaska, Florida, South Dakota, Texas, and Washington have no individual income tax.

Some states have 0 sales tax. T or F

True; some states have 0 sales tax (no sales tax: Alaska, Delaware, New Hampshire, Montana, and Oregon)

Laffer Curve

is a graph that shows the economist Arthur Laffer's theory of how tax cuts affect tax revenues and economic growth

Demand-side vs supply-side fiscal policies

1) demand-side economics uses fiscal policy to encourage consumers to spend more 2) supply-side economics focuses on cutting the cost of production to encourage producers to supply more.

Provide an example of what happens when Public transfer payment occurs to stabilize the economy

1. During a recession more people are unemployed and qualify to receive unemployment compensation and other government benefits, such as food stamps or welfare payments. When people receive these benefits, they gain a certain amount of income to spend, and the effects of the recession are less severe than they would be without the transfer payments. 2. When the economy improves, fewer people qualify for food stamps, unemployment compensation, and other entitlements, and government spending automatically decreases. This automatic decrease keeps the economy from growing too fast.

Provide an example of what happens when Progressive Income Taxes do to stabilize the economy

1. During prosperous times, individual incomes rise, and some individuals move into higher tax brackets. These taxpayers pay more in taxes and do not have all of their increased income to spend or save. By preventing some of the increased income from entering the economy, this automatically higher taxation keeps the economy from growing too quickly and helps keep inflation in check. 2. On the other hand, during a recession, individuals earn less income and may move into lower tax brackets. Therefore, lower incomes result in lower taxes, which automatically reduce the impact of the recession.

What are the 3 monetary tools of the Fed?

1. Open Market Operations: are the sales and purchase of federal government securities. 2. Adjusting the Reserve Requirements: The RRR affects the money supply through the deposit multiplier formula. Increasing the RRR can reduce the money supply; decreasing the RRR can expand the money supply. 3. Adjusting the Discount Rate

What are the two Automatic stabilizers for the economy?

1. Public Transfer Payments 2. Progressive Income Taxes

What are the 4 main tax bases?

1. individual income tax (based on a person's earnings), 2. corporate income tax (based on the corporation's profits), 3. sales tax (based on the value of goods/services at the time of sale), 4. property tax (based on the value of an individual's or business's assets, generally real estate)

What are some of the limitations of fiscal policy?

1. policy lags, 2. timing, 3. rational expectations theory, 4. political issues, 5. regional differences

What are the 3 types of tax structures?

1. progressive tax: places a higher percentage rate of taxation on high-income people; 2. regressive tax: takes a larger percentage of income from low-income people; 3. flat or proportional tax: takes the same percentage of income from all taxpayers regardless of income

What is the percentage most banks have to have for the required reserve ratio (RRR)?

10% for most banks

GDP formula = ? (Gross Domestic Product)

= C + I + G + F [total market value of all consumer goods (C), investment goods (I), government goods (G), and net exports (F)]

What is a tax?

A ______________ is a mandatory payment to a local, state, or national government.

What is revenue?

A ________________ is government income from taxes and other nontax sources.

What Policies control inflation?

Contractionary monetary policy is to tighten up the economy by decreasing inflation and increasing interest rates. The Fed will sell bonds on the open market or raise the discount rate or the reserve requirement as contractionary monetary policy tools. Contractionary fiscal policy tools include decreased government spending or tax increases.

What is the difference between Keynesian vs Trickle Down economics?

Demand-side fiscal policy = goal is to increase aggregate demand and lower unemployment during a recession, active role of government, government spending, deficit spending. Supply-side fiscal policy = goal is to increase aggregate supply, lower taxes/government spending/regulation, incentivize producers to work/save/invest more.

Who decides the federal budget?

Each year the President and Congress work together to establish the ______________ _____________ a plan for spending federal tax money.

Two tools of federal government and how/when they're used (taxes, government spending) (book pages 448-450)

Expansionary fiscal policy may involve increased government spending, decreased taxes, or both. Contractionary fiscal policy the government may choose to decrease government spending or increase taxes in order to control inflation.By cutting spending, the government takes money out of the economy. This decreased government spending results in less income for individuals or businesses that are directly affected by the cuts in government programs. As aggregate demand decreases, the rise in the price level is stopped, and inflation is brought under control.

Explain RRR and why might the Fed change it?

The higher percentage of the RRR then less money is available for loans and less money in the economy. The Fed might change it depending upon the economy. Raise the RRR if the economy is prosperous and lower the RRR if the economy is in a recession. When the Fed reduces the reserve requirement, it's exercising expansionary monetary policy. That creates more money in the banking system. When the Fed raises the reserve requirement, it's executing contractionary policy. That reduces liquidity and slows economic activity.

Top source of federal tax revenue

The largest source of taxes for the federal government is the individual income tax.

How does the Public Transfer Payment work an automatic stabilizer?

The mandatory government spending for unemployment compensation, food stamps and other entitlement programs automatically set up a flow of money into the economy. This helps stabilize the economy automatically. It helps to control aggregate demand, this automatic stabilizer keeps prices from rising too quickly and leading to inflation.

Explain Timing Issues as a limitation of fiscal policy

The timing of fiscal policy should coordinate with the business cycle. 1. If the timing of the policy is good, fluctuations in the business cycle will be less severe. 2. If the timing is bad, however, it could make matters worse. For example, if the economy is already moving out of a recession when an expansionary fiscal policy takes effect, the result could be inflation.

What are the causes of the deficit?

There are 4 causes: 1. national emergencies (examples: wars and catastrophic weather events), 2. a desire for more public goods/services (examples: interstate highway system, dams, flood-control projects, and airports) 3. stabilization of the economy (example: Great Depression - public works projects to build roads, bridges, schools, and parks), and 4. the role of government in society (Social Security, Medicare, Medicaid, and unemployment insurance to provide help for those in need; entitlement programs so require funding each year).

What are the duties of the Federal Reserve System (Central Bank or The Fed)?

There are three common duties that all central banks perform: 1. holding reserves, 2. assuring stability of the banking and monetary systems by providing regulation and oversight to make sure that banks follow sound practices in their operations, and 3. lending money to banks and the government - It accepts and holds deposits in the form of cash reserves, transfers funds between banks or between banks and the government, and makes loans to these institutions. AKA as a Banker's bank. 4. distributes currency

What is the purpose of fiscal policy?

To stabilize and strengthen the economy. To reduce economic slowdowns, which result in unemployment, and to curb inflation.

What 4 factors influence how much money individuals and businesses need? (factors affecting demand for money).

cash on hand, interest rates, the cost of consumer goods and services, and the level of income.

What does the Congressional Budget Office (CBO) do?

helps the House and Senate develop guidelines for different appropriations, which are set amounts of money set aside for specific purposes. Note: Congress votes on the final budget and sends it to the president for approval.

Explain rational expectations theory as a limitation of fiscal policy

individuals and business firms expect that changes in fiscal policy will have particular outcomes, and they take actions to protect their interests against those outcomes.

Withholding

is money taken from pay before the worker receives it.

What is the RRR (required reserve ratio)?

is the fraction of the bank's deposits that must be kept in reserve by the bank, to control the amount a bank can loan. Money on deposit in excess of the required reserve amount can be loaned out. The money in reserve may be stored as cash in the bank's vault or deposited with the Fed.

What is the prime rate?

is the interest rate that banks charge their best customers.

What is the discount rate?

is the interest rate that the Fed charges when it lends money to other banks.

What is the largest item in our discretionary spending?

national defense takes up about 50 percent of the total budget

What is deficit spending?

occurs when a government spends more than it collects in revenue for a specific budget year.

What is the type of tax structure most states have for income tax?

progressive

How does the government spend money?

provide public goods and various other services

Discretionary fiscal policy

refers to actions selected by the government to stabilize the economy. This type of policy involves an active government response, through choices about taxes or government spending, to help stabilize the economy.

What type of tax structure do states have for sales tax? And Why?

regressive; because they are applied to sales, not income. For example, although a sales-tax rate is applied equally to all items subject to the tax, the tax as a percentage of income is regressive. This is because low-income earners tend to spend a higher proportion of income than do high-income earners. Suppose that a state charges 5 percent sales tax on certain goods sold in the state. If the Jones family earns $20,000 and spends $15,000 on taxable goods, they pay $750 in sales taxes (5 percent of $15,000), or 3.75 percent of their income. If the Smith family earns $50,000 and spends $25,000 on taxable goods, they pay $1,250 in sales tax (5 percent of $25,000), or 2.5 percent of their income.

What is mandatory spending?

spending that is required by law; makes up well over half of all federal spending.

What is discretionary spending?

spending that the government must authorize each year

Spending multiplier effect

states that a small change in spending causes a much larger change in GDP.

What is the role of the Federal Open Market Committee (FOMC)

supervises the sales and purchase of government securities.

How does the government raise money?

taxes and borrows money by issuing government bonds, through the Department of the Treasury; these are gov't securities like savings bonds, Tbonds, Tnotes, Tbills

How does the government raise money?

taxes and nontax sources such as borrowing, and lotteries

What are the Goals of the Fed?

to promote growth and stability in the American economy. The purpose of monetary policy is to curb inflation and reduce economic stagnation or recession. By focusing on these goals, the Fed tries to promote full employment and growth without rapid increases in prices or high interest rates.