ECON WEEK 5

What is the multiplier principle?

One individual's expenditure becomes the income of another.

What is a budget deficit?

A situation in which total government spending exceeds total government revenue during a specific time period, usually one year.

On the supply side, lower tax rates increase increase what, what, and what?

the incentive of people to work, supply resources, and use them more efficiently and thereby increase aggregate supply.

f the government's revenue from taxes and other sources is equal to its total expenditure, what is present?

A balanced budget?

What is discretionary fiscal policy?

A change, in laws or appropriation levels, that alters government revenues and/or expenditures.

According to Keynesian referring to the changes in pricing?

A decline in total spending would result with a reduction in sales and rising inventories.

What is countercyclical policy?

A policy that tends to move the economy in an opposite direction from the forces of the business cycle. Such a policy would stimulate demand during the contraction phase of the business cycle and restrain demand during the expansion phase.

What is restrictive fiscal policy?

A reduction in government expenditures and/or an increase in tax rates such that the expected size of the budget deficit declines (or the budget surplus increases).

Why is the impact of a temporary tax cut weaker than a permanent one?

A temporary tax cut provides a short-term windfall increase in current income, but it does not exert much impact on either long-term income or the incentive to earn. Moreover, compared to a permanent tax reduction, a temporary tax cut generates uncertainty. As a result, market participants, unsure about whether and how policies might change, often choose to cancel or delay long-term business ventures. Thus, temporary tax rebates and even rate reductions are largely ineffective as a tool for the promotion of recovery and long-term growth.

What will businesses be able to do in the event of Keynesian equilibrium?

Businesses will be able to sell the quantity of goods and services they are currently producing.

How might policymakers use the budget to stimulate aggregate demand?

First, an increase in government purchases of goods and services will directly increase aggregate demand. As the government spends more on highways, flood-control projects, education, and national defense, for example, these expenditures will increase demand in the goods and services market. Second, changes in tax policy will also influence aggregate demand. For example, a reduction in personal taxes will increase the current disposable income of households. As their after-tax income rises, people will spend more on consumption. In turn, this increase in consumption will stimulate aggregate demand. Similarly, a reduction in business taxes increases after-tax profitability, which will stimulate both business investment and aggregate demand.

Until now, we have focused almost exclusively on the first factor, but economics provides several important insights on the second—the use of borrowing to benefit current citizens at the expense of future generations. Consider the following three factors.

First, as public-choice analysis indicates, democratically elected politicians will find debt financing attractive. Second, unfunded promises are another form of debt finance, and the future tax burden of these programs is certain to increase in the years immediately ahead. Third, the political incentive structure explains why countries might get caught in a vicious circle of debt financing, higher taxes, and sluggish growth.

There are three major reasons why high tax rates are likely to retard the growth of output

First, as we have explained, high marginal tax rates discourage work effort and productivity. Second, high tax rates will adversely affect the rate of capital formation and the efficiency of its use. Third, high marginal tax rates encourage people to substitute less-desired tax-deductible goods for more-desired nondeductible goods.

What are the two different sources that may change the size of the deficit or surplus?

First, changes in the size of the deficit or surplus may merely reflect the state of the economy. Second, changes in the deficit or surplus may reflect discretionary fiscal policy.

According to the crowding-out theory, what two factors will largely, if not entirely, offset the stimulus effects of a larger budget deficit?

First, the higher interest rates will reduce private investment, which will directly restrain aggregate demand. Second, the higher interest returns will also attract an inflow of foreign capital, which will moderate the increase in interest rates, but it will also cause the dollar to appreciate.

Critics of Keynesian economics argue that the side effects of the increased spending and expanded debt will exert an adverse impact on both the recovery process and long-term growth. They raise three major points in support of their view.

First, they argue that the increased borrowing and expansion of government debt will mean higher future interest payments and tax rates, and this will retard long-term growth. Even if the government is able to borrow at low interest rates during a downturn, as has been the case for the most recent recession, some combination of higher interest rates and higher taxes will be required for the future financing and refinancing of the larger debt. Second, government spending is driven by political rather than economic considerations. The political process does not have anything like profit and loss that will direct resources into productive projects and away from unproductive ones. Political favoritism will become more important, and efficient allocation of resources less. Predictably, counterproductive use of resources will result. Third, an increase in politically directed spending will lead to more rent-seeking. Incentives matter. When the government is spending a lot on special projects, subsidies, grants, and income transfers, businesses and other organized groups will spend more on lobbying, political contributions, and other efforts designed to attract the government funds.

During the Great Depression, John Maynard Keynes developed a model that implied a market economy could remain below full employment for lengthy periods of time.

In the Keynesian model, equilibrium occurs when the spending on consumption, investment, government purchases, and net exports is equal to total output. Firms will produce only the quantity of goods and services they believe consumers, investors, governments, and foreigners plan to buy. If this spending level is less than full-employment output, firms will not alter their production levels and the less than full-employment rate of output will persist. Keynes believed this was the situation during the Great Depression.

What did Keynes reject?

Keynes rejected that low wages and low interest rates and eliminate high rates of unemployment.

According to classical view, crowding out has what effect on the economy?

Little - Debt financing and larger budget deficits will not stimulate aggregate demand. Neither will they affect output and employment. Similarly, the real interest rate is unaffected by deficits because people will save more in order to pay the higher future taxes. In the new classical model, fiscal policy is completely impotent.

Keynes refers to the multiplier by what?

Marginal propensity to consume (MPC) Additional current consumption divided by additional current disposable income.

The crowding-out model indicates that expansionary fiscal policy will lead to higher real interest rates and less private spending, particularly for investment. In an open economy, the higher interest rates will also lead to the following secondary effects: an inflow of capital, an appreciation of the dollar, and a reduction in net exports. The crowding-out theory implies that these secondary effects will largely offset the demand stimulus of expansionary fiscal policy. The new classical model stresses that financing government spending with debt rather than taxes changes the timing, but not the level, of taxes. According to this view, people will expect higher future taxes, which will lead to more saving and less private spending. This will tend to offset the expansionary effects of a deficit. Keynesian and non-Keynesian economists are now largely in agreement on the following three issues: (1)Proper timing of discretionary fiscal policy is both difficult to achieve and crucially important. (2)automatic stabilizers reduce the fluctuation of aggregate demand and help promote economic stability, and (3)fiscal policy is much less potent than early Keynesians thought. When fiscal policy changes marginal tax rates, it influences aggregate supply by altering the attractiveness of productive activity relative to leisure and tax avoidance. Other things being constant, lower marginal tax rates will increase aggregate supply. Supply-side economics should be viewed as a long-run strategy, not a countercyclical tool. Keynesian economists believe that increases in government spending financed by borrowing will increase aggregate demand and help promote recovery from a serious recession like that of 2008-2009. Non-Keynesian economists argue that Keynesian policies will lead to higher future interest rates and taxes, inefficient use of resources, and wasteful rent-seeking that will both retard recovery and slow future economic growth. Tax cuts can generally begin to exert an impact on the economy more rapidly than spending increases. Further, rate reductions and permanent rate changes will exert a larger impact than tax rebates and temporary tax cuts. Political decision-makers have responded to the 2008-2009 recession with large increases in both government spending and budget deficits. The deficits have pushed federal debt to levels unseen since World War II. Potential danger accompanies high debt levels because higher taxes will be necessary to finance interest payments and the higher taxes will slow economic growth. In turn, the slower economic growth will reduce government revenues, making it more difficult to control future deficits and debt.

Suppose that you are a member of the Council of Economic Advisers. The president has asked you to prepare a statement on the question, "What is the proper fiscal policy for the next twelve months?" Prepare such a statement, indicating (a)the current state of the economy (that is, the unemployment rate, growth in real income, and rate of inflation) and (b)your fiscal policy suggestions. Should the budget be in balance? Explain the reasoning behind your suggestions. 2. What is the crowding-out effect? How does it modify the implications of the basic Keynesian model with 1. Suppose that you are a member of the Council of Economic Advisers. The president has asked you to prepare a statement on the question, "What is the proper fiscal policy for the next twelve months?" Prepare such a statement, indicating (a)the current state of the economy (that is, the unemployment rate, growth in real income, and rate of inflation) and (b)your fiscal policy suggestions. Should the budget be in balance? Explain the reasoning behind your suggestions. Answer The crowding-out effect is the theory that budget deficits will lead to higher real interest rates, which retard private spending. The crowding-out effect indicates that fiscal policy will not be nearly as potent as the simple Keynesian model implies. The new classical theory indicates that anticipation of higher future taxes (rather than higher interest rates) will reduce private spending when government expenditures are financed by debt. 3. What is the crowding-out effect? How does it modify the implications of the basic Keynesian model with regard to fiscal policy? How does the new classical theory of fiscal policy differ from the crowding-out model? 4. Suppose that the government provides each taxpayer with a $1,000 tax rebate financed by issuing additional Treasury bonds. Outline alternative views that predict how this fiscal action will influence interest rates, aggregate demand, output, and employment. 5. Will increases in government spending financed by borrowing help promote a strong recovery from a severe recession? Why or why not? 6. Outline the supply-side view of fiscal policy. How does this view differ from the various demand-side theories? Would a supply-side economist be more likely to favor a $1,000 rebate to all taxpayers or an equivalent reduction in marginal tax rates? Why? 7. Are changes in discretionary fiscal policy likely to be instituted in a manner that will reduce the ups and downs of the business cycle? Why or why not? 8. "Bill Clinton reduced government spending and shifted the federal budget toward surplus, while Presidents Bush and Obama adopted the Keynesian policies of spending growth financed by borrowing. If we want to return to prosperity, we need to discard the Bush-Obama policies and return to those of President Clinton." Explain why you either agree or disagree with this view. 9. If the government becomes more heavily involved in subsidizing some businesses and sectors of the economy while levying higher taxes on others, how will this influence the quantity of rent seeking? How will this affect long-term growth? Explain your response. 10. Does fiscal policy have a strong impact on aggregate demand? Did the shift of the federal budget from deficit to surplus during the 1990s weaken aggregate demand? Did the government spending increases and large budget deficits of 2008-2011 strengthen aggregate demand? Discuss. Answer In the Keynesian model, investment is determined by factors other than the interest rate. Thus, budget deficits would not exert much effect on capital formation. In the crowding-out model, capital formation would be reduced because the budget deficits would lead to higher interest rates, which would crowd out private investment. In the new classical model, households will save more, and, as a result, budget deficits could be financed without either an increase in the interest rate or a reduction in capital formation. 11. How do persistently large budget deficits affect capital formation and the long-run rate of economic growth? Do the proponents of the Keynesian, crowding-out, and new classical theories agree on the answer to this question? Discuss. 12. What is the current rate of unemployment? How rapidly has real GDP grown during the past three years? What do these figures indicate about the validity of the Keynesian view? Explain. 13. Marginal tax rates were cut substantially during the 1980s, and although rates were increased in the early 1990s, the marginal rates applicable in the highest income brackets were still well below the top rates of the 1960s and 1970s. How did the lower rates of the 1980s and 1990s affect the share of taxes paid by high-income taxpayers? Were the lower rates of the 1980s and 1990s good or bad for the economy? Discuss. Answer Yes. Only the lower rates would increase the incentive to earn marginal income and thereby stimulate aggregate supply. 14. If the impact on tax revenues is the same, does it make any difference whether the government cuts taxes by (a)reducing marginal tax rates or (b)increasing the personal exemption allowance? Explain. 15. The "cash for clunkers" program of 2009 provided a subsidy of about $4,000 to those willing to buy a new car and have their old one destroyed. How did this policy affect the demand for new cars during the five months of the program? How did it affect the demand for new cars after it expired? How did it affect the price and availability of used cars? Do you think it would be a good idea to adopt a permanent program like this? Why or why not? Answer No. If it takes more workers to generate a specific amount of energy with wind power, this implies that wind power is a more costly method of generating energy than either coal or natural gas. Thus, the implications of the statement are exactly the opposite of what the wind energy proponents imply. 16. The American Wind Energy Association argues for additional government support because wind-generated electricity creates more employment per kilowatt-hour than the alternatives: 27 percent more jobs than coal and 66 percent more than natural gas. Is this a sound economic argument for increased use of wind power? If the jobs created pay similar wages, what does the statement imply about the cost of generating energy with wind power relative to coal and natural gas?

What does the The crowding-out effect imply?

The demand stimulus effects of budget deficits will be weak because borrowing to finance the deficits will increase interest rates and thereby crowd out private spending on investment and consumption.

When an economy is in a recession, Keynesians do not believe that reductions in either resource prices or interest rates will promote recovery. As a result, market economies are likely to experience recessions that are both severe and lengthy.

The federal budget is the primary tool of fiscal policy. Rather than balancing the budget annually, Keynesians believe that fiscal policy should reflect business cycle conditions. During a recession, fiscal policy should become more expansionary (a larger deficit should be run). During an inflationary boom, fiscal policy should become more restrictive (shift toward a budget surplus).

What happens during a budget deficit?

The government must borrow funds to finance the excess of its spending relative to revenue. It borrows by issuing interest-bearing bonds that become part of what we call the national debt, the total amount of outstanding government bonds.

What is the expenditure multiplier?

The ratio of the change in equilibrium output to the independent change in investment, consumption, or government spending that brings about the change. Numerically, the multiplier is equal to 1 divided by when the price level is constant.

What are the advantage of having the automatic stabilizers?

They institute countercyclical fiscal policy without the delays associated with legislative action. They minimize the problem of proper timing, in other words. On the one hand, when unemployment is rising and business conditions are slow, these stabilizers automatically reduce tax revenues collected and increase government spending, giving the economy a shot in the arm. On the other hand, automatic stabilizers help apply the brakes to an economic boom, increasing tax revenues and decreasing government spending. Three of these built-in stabilizers deserve specific mention: unemployment compensation, the corporate profit tax, and the progressive income tax.

What did Keynes argue for?

Wages and interest rates are inflexible in a downward direction and lower interest rates will fail to stimulate additional investment.

Why is unemployment compensation an automatic stabilizer?

When an economy begins to dip into a recession, the government will pay out more money in unemployment benefits as the number of laid-off and unemployed workers expands. Simultaneously, the receipts from the employment tax that finance the unemployment compensation system will decline because fewer workers are paying into the system. Therefore, this program will automatically run a deficit during a business slowdown. In contrast, during an economic boom, the tax receipts from the program will increase because more people are now working, and the amount paid out in benefits will decline because fewer people are unemployed. Thus, the program will automatically tend to run a surplus during good times. So without any change in policy, the unemployment compensation program has the desired countercyclical effect on aggregate demand.

According to the Keynesian view, fluctuations in total spending (aggregate demand) are the major source of economic instability. Keynesians believe that market economies have a tendency to fluctuate between economic booms driven by excessive demand and recessions resulting from insufficient demand. The multiplier concept magnifies these fluctuations.

When an economy is operating below full-employment capacity, increases in aggregate expenditures lead to an expansion in both output and employment. Once capacity is reached, further expansions in expenditures lead only to higher prices. The Keynesian model highlights the importance of maintaining demand at a level consistent with full employment and price stability.

What is the progressive income tax an automatic stabilizer?

When incomes grow rapidly, the average personal income tax liability of individuals and families increases. With rising incomes, more people will find their income above the "no tax due" cutoff. Others will jump up into higher tax brackets. Therefore, during an economic expansion, personal income tax revenues increase more rapidly than income, because income will grow at a more incremental pace. Other things constant, the budget moves toward a surplus (or smaller deficit), even though the economy's tax rate structure is unchanged. Conversely, when incomes decline, many individuals will be taxed at lower rates or not at all. Income tax revenues will fall more rapidly than income, automatically enlarging the size of the budget deficit during a recession.

Supply-side economics is a what, what, not what?

long-run, growth-oriented strategy, not a short-run stabilization tool.

The federal budget is the primary tool of fiscal policy. When the supply of money is constant, government expenditures must be financed with either. . .

(1) taxes or revenues derived from other sources (2)borrowing

Although an abrupt increase in saving may exert an adverse impact on the economy in the short run, saving provides the financing for investment that powers long-term growth. Moreover, a healthy economy is dependent on households saving regularly and avoiding excessive debt.

1. What determines the equilibrium rate of output in the Keynesian model? Why did Keynes think the Great Depression lasted so long and the unemployment rate remained so high throughout the 1930s? 2. What do Keynesians think cause fluctuations in output? What must be done to maintain full-employment capacity? 3. What is the multiplier principle? What determines the size of the multiplier? Does the multiplier make it more or less difficult to stabilize the economy? Explain. 4. What is a budget deficit? How are budget deficits financed? Why do Keynesians believe that budget deficits will increase aggregate demand? 5. From a stabilization standpoint, why is proper timing of a change in fiscal policy important? Is it easy to time fiscal policy changes properly? Why or why not? 6. According to the Keynesian view, what fiscal policy actions should be taken if the unemployment rate is high and current GDP is well below potential output? 7. Are discretionary changes in fiscal policy likely to be instituted in a manner that will help smooth theups and downs of the business cycle? Why or why not? 8. What are automatic stabilizers? Explain their major advantage. 9. "An increase in aggregate demand will tend to increase real output by a larger amount when unemployment is widespread than when the economy is operating at or near full employment." Is this statement true? Explain. 10. When output and employment slowed in early 2008, the Bush Administration and the Democratic Congress passed legislation sending households a check for $600 for each adult (and $300 per child). These checks were financed by borrowing. Would a Keynesian favor this action? Why or why not? 11. If uncertainty about the future causes households to increase their saving and reduce their consumption spending during a recession, how will this affect the economy? Explain. If households save little and spend most of their income on current consumption, how will this affect the economy? Explain.

What is the crowding out effect?

A reduction in private spending as a result of higher interest rates generated by budget deficits that are financed by borrowing in the private loanable funds market.

What is a balanced budget?

A situation in which current government revenue from taxes, fees, and other sources is just equal to current government expenditures.

What is a budget surplus?

A situation in which total government spending is less than total government revenue during a time period, usually a year.

What is expansionary fiscal policy?

An increase in government expenditures and/or a reduction in tax rates, such that the expected size of the budget deficit expands.

Are the current high levels of government debt dangerous?

Are the current high levels of government debt dangerous? When thinking about this question, it is important to recognize two different factors underlying the political attractiveness of debt financing: (1)its potential use as a countercyclical stabilization tool and (2)its use to shift the cost of government, particularly the visible costs, from current to future generations.

Changes in fiscal policy must be timed properly if they are going to exert a stabilizing influence on an economy. The ability of policy-makers to time fiscal policy changes in a countercyclical manner is reduced by (1)the inability of the political process to act rapidly, (2)the time lag between when a policy change is instituted and when it affects the economy, and (3)the inability to forecast accurately the future direction of the economy.

Automatic stabilizers help promote stability because they are able to add demand stimulus during a recession and restraint during an economic boom without legislative action.

What are automatic stabilizers?

Built-in features that tend automatically to promote a budget deficit during a recession and a budget surplus during an inflationary boom, even without a change in policy.

What do Keynesians believe referring to changes in output?

Changes in output, not the changes in the prices, will direct the economy towards equilibrium.

Rather than balancing the budget annually, Keynesians stressed the importance of?

Countercyclical policy.

What are is supply-side economics?

Economists who believe that changes in marginal tax rates exert important effects on aggregate supply.

What concept did Keynes introduce?

Equilibrium.

What would happen is spending is deficient (less-then full employment output)?

High rate of unemployment will remain constant and output will remain underneath the economy's potential. This will remain constant if spending on goods and services remains week.

What is Keynesian Equilibrium?

His equilibrium would take place during when total spending in the economy is equal to current output.

What happens to the incomes of people taking part in the multiplier principle?

Income recipients will spend a portion of their additional earnings on consumption. In turn, their consumption expenditures will generate additional income for others who will also spend a portion of it.

Most macroeconomists—both Keynesian and non-Keynesian—are now largely in agreement on the following three issues.

Proper timing of discretionary fiscal policy is both difficult to achieve and crucially important. Automatic stabilizers reduce fluctuations in aggregate demand and help keep the economy on track. Fiscal policy is much less potent than the early Keynesian view implied.

Why is additional spending an issue for normal economic conditions?

Resources will be 'bid' away to other activities resulting with upward pressure on prices and additions to income will be smaller than the multiplier analysis implies.

Keynesians believe that a shift toward a more...

Restrictive fiscal policy is the proper prescription with which to combat inflation generated by excessive aggregate demand.

What will come as a result of crowding in?

Restrictive fiscal policy will be largely ineffective as a weapon against inflation.

What will crowd in private spending?

Restrictive fiscal policy.

Why in Keynesian equilibrium will businesses be able to sell what they are currently producing?

The businesses' inventories will neither be rising nor falling, and therefore have no reason to expand nor contract their current output.

What is the corporate profit tax an automatic stabilizer?

The corporate profit tax is a highly important automatic stabilizer because corporate profits are highly sensitive to cyclical conditions. During a recession, corporate profits decline sharply, and so, too, do corporate tax payments. In turn, the decline in tax revenues will enlarge the size of the budget deficit. In contrast, when the economy is expanding, corporate profits typically increase much more rapidly than wages, income, or consumption. This increase in corporate profits will result in a rapid increase in the "tax take" from the business sector during the expansion phase of the business cycle. Thus, corporate tax payments will go up during an expansion and fall rapidly during a contraction, even though no new legislative action has been instituted.

Reductions in tax rates can increase both what and what?

The disposable income and the incentive to earn almost immediately In contrast, government-spending projects are often a lengthy process spread over several years. For example, the Congressional Budget Office estimated that only 15 percent of the spending funded by the stimulus package passed in February 2009 occurred during the initial year, while nearly half (48 percent) was not spent until 2011 and beyond.

If discretionary fiscal policy changes are going to reduce economic instability, they must be what and why?

Times correctly because fiscal stimulus must be felt during recessions and restraint during inflationary booms. But proper timing of fiscal policy is not an easy task. There are three major reasons why this is true. First, a change in fiscal policy will require legislative action. But the political process moves slowly. This is particularly true in a country like the United States that has a number of checks and balances built into its political system. Congressional committees must meet, hear testimony, and draft legislation. Key legislators may choose to delay action in an attempt to amend the legislation so that it benefits their own constituents and supporters. Passage will require the approval of the House of Representatives, the Senate, and the president. Predictably, this process will take a significant amount of time. Second, a change in policy will not immediately impact the macroeconomy. Even after a policy change is adopted, another six to twelve months will generally pass before it will have much impact on the economy. If government expenditures are going to be increased, time will be required for competitive bids to be submitted and government contracts granted. Contractors might not be able to begin work right away. Although a tax cut might exert some stimulus more quickly, typically several months will pass before the primary effects of the cut are felt throughout the economy. Third, because of these delays, if fiscal policy is going to exert a stabilizing influence, policy-makers need to know what economic conditions are going to be like twelve to eighteen months in the future. However, this is a big problem because our ability to forecast when the economy is about to dip into a recession or experience an economic boom is extremely limited. Therefore, in a world of dynamic change and unpredictable events, macroeconomic policy making is a little bit like lobbing a ball at a target that often moves in unforeseen directions.

As we previously discussed, time lags, inability to forecast the future direction of the economy, and the political process all reduce the likelihood that discretionary fiscal policy will be used effectively to what?

reduce the ups and downs of the business cycle.

Keynesians argue that when a large number of households try to increase their saving and reduce their consumption, total saving may not increase. Instead, what happens?

the reduction in consumption may reduce the overall demand for goods and services, causing businesses to reduce output and lay off workers. In turn, as output and income fall, saving may decline rather than increase. This is often referred to as the paradox of thrift.

Will increases in government spending financed by borrowing speed recovery from a severe recession?

ya During a severe recession like that of 2008-2009, interest rates may essentially fall to zero, and even these low rates may fail to stimulate much private investment. Under these conditions, crowding out of private spending will be minimal. Moreover, unemployed and underemployed resources will be widespread, and, as a result, the additional government spending will have a substantial multiplier effect. Thus, Keynesians argue that expansionary fiscal policy will stimulate aggregate demand and help promote recovery from serious recessions.

What happens to total spending if it falls below the full-employment price level.

Business firms would cut-back on employment, reduce spending, and cut the level of output spending. This would result with the level of unemployment and spending remaining constant until changed.

How can the central message of Keynes be summarized?

Businesses will produce only the quantity of goods and services they believe consumers, investors, governments, and foreigners will plan to buy.

What did Keynes believe in?

By spending motivated firms to supply goods and services it may let spending fall if consumers and investors became pessimistic about the future then firms would respond by cutting back production. Less spending would thus lead to less output.

When an economy is operating below its potential capacity, the Keynesian prescription calls for what?

Expansionary fiscal policy—a deliberate change in expenditures and/or taxes that will increase the size of the government's budget deficit.

Keynes argued what about market forces?

Market forces could not maintain spending levels consistent with full employment because even minor disturbances will be amplified to become major disturbances.

What will happen if the increase in spending is the result of a government project financed by taxes?

The higher taxes would reduce spending in other areas, at least partially offsetting the impact of the multiplier.

What is the paradox of thrift?

The idea that when many households simultaneously try to increase their saving, actual saving may fail to increase because the reduction in consumption and aggregate demand will reduce income and employment.

What can the term 'multiplier' be used to indicate?

The number by which the initial investment would be multiplies to obtain the total increase in the economy's income.

What does the size of the multiplier rely on?

The proportion of the additional income that households choose to spend on consumption.

What will happen if the increase in spending is finance by borrowing?

There will be upward pressure on real interest rates, which will reduce spending in other areas.