Economics Today The Macro View Ch. 13 Fiscal Policy

So any change in the level of taxes leads to

a smaller change in consumption and expenditures compared to the change in taxes.

You are a member of congress. The economy is currently experiencing an inflationary gap. Which of the following are fiscal policies that congress can enact in an attempt to correct the economy? What will happen in a recessionary gap?

A decrease in government spending and an increase in taxes. An increase in government spending and a decrease in taxes.

During normal times, fiscal policy probably achieves most of its impact through

the workings of automatic stabilizers.

During normal​ times, fiscal policy probably achieves most of its impact through A. the workings of time lags. B. the workings of discretionary fiscal policy. C. the workings of automatic stabilizers. D. It is always ineffective.

C. the workings of automatic stabilizers.

Which of the following is not an automatic​ stabilizer? A. Progressive tax rates. B. Defense spending. C. Unemployment compensation. D. All of the above are automatic stabilizers. A progressive tax system is one in which the tax rates A. increase as income increases. B. decrease as income increases. C. are dependent on the progress of the​ economy; for example if real GDP grows by​ 3% then tax rates grow by​ 3%. D. remain constant as income increases.

1) B. Defense spending. 2) A. increase as income increases.

Suppose that Congress enacts a significant tax cut with the expectation that this action will stimulate aggregate demand and push up real GDP in the short run. In​ fact, however, neither real GDP nor the price level changes significantly as a result of the tax cut. This outcome can be explained by all of the​ following, except one. Which one of the following is the​ exception? A. Automatic stabilizers. B. Indirect crowding out. C. The Ricardian Equivalence Theorem. D. The​ Fed's contractionary monetary policy.

A. Automatic stabilizers.

Suppose that the economy is shown to the right. This economy is currently experiencing A. an inflationary gap. B. a recessionary gap. C. hyperinflation. D. crowding out.

B. a recessionary gap. draw and label the fiscal policy correction that will bring the economy to full employment. (Draw a AD1 line to intersect point B)

During normal economic​ times, when there is not​ "excessive" unemployment or​ inflation, discretionary fiscal policy A. is a way of effectively spurring economic growth. B. is probably not very effective due to lags and the uncertainty created by repeated tax policy changes. C. is not used due to legal restrictions on the ability of Congress to make policy. D. is used frequently to effectively​ fine-tune the economy.

B. is probably not very effective due to lags and the uncertainty created by repeated tax policy changes.

Appendix D: The Balanced-Budget Multiplier

Balanced-budget increase in real spending. --The government increases spending by $1 and pays for it by raising current taxes by $1. Balanced-budget multiplier is equal to 1.

Suppose that the economy is in​ short-run equilibrium but there is an inflationary gap. Which of the following is an example of a discretionary fiscal policy that could be used to return the economy to​ full-employment real​ GDP? A. A decrease in taxes. B. An increase in the interest rate. C. A decrease in government spending. D. An increase in unemployment insurance. E. An increase in the money supply.

C. A decrease in government spending.

Automatic stabilizers

Cause changes in the economy without the action of congress and the president.

Fiscal policy refers to

Discretionary changes in government spending and taxes.

The government just passed a new tax bill that will be applied to the economy next year. Most people will not immediately feel the impact of this new tax bill and not adjust their W-2 tax forms. The impact of the new tax bill wont become apparent to them until the following April when their tax bills are due . This problem is referred to as the.

Effect time lag, and it makes it difficult to use discretionary fiscal policy to close a recessionary gap.

Expansionary fiscal policy that creates a budget deficit can lead to crowding out. This crowding out effect is exhibited by

Increased government expenditures and decreased investment.

The government reduces its taxes without decreasing its expenditures; to cover the resulting budget deficit, it issues more bonds, thereby pushing up the market interest rate and discouraging private planned investment spending. This is an example of

Indirect crowing out from a fiscal policy action.

The purpose of automatic stabilizers is to

Lessen the impact of unemployment in a recession and slowdown inflation during an expansion.

Fiscal policy time lags are

Long - a policy designed to correct a recession may not produce results until the economy is experiencing inflation. • Variable in length - they can be from 1-3 years, and the timing of the desired effect cannot be predicted. • Because fiscal policy time lags tend to be variable, policymakers have a difficult time fine-tuning the economy.

Tax increase Tax cut

Lowers prices. lowers demand Increases prices. increases demand.

When considering a change in government spending in the traditional Keynesian model, which of the following expenditures is considered an offset to government spending?

None of these above are considered offsets. Taxes would be the off set!!!

Suppose that congress enacts a lump-sim tax cut of $750 billion. The marginal propensity to consume is equal to 0.75 If Ricardian equivalence holds true, equilibrium Real GDP will If Ricardian equivalence holds true, savings will

Remain unchanged. increase by the amount of the tax cut.

Automatic, or built-in, stabilizers

Special provisions of certain federal programs that cause changes in desired aggregate expenditures without the action of Congress and the president. Examples are federal progressive tax system and unemployment compensation.

An increase in government spending will

Stimulate economic activity.

Another year and a half elapses following passage of the government spending boost. The government has undertaken no additional policy actions, nor have there been any other events of significance. Nevertheless, by the end of the second year, real GDP has returned to its original level, and the price level has increased sharply. This possibly happened because.

The LRAS was vertical; the increase in government spending raised aggregate demand and resulted in only a rise in the price level in the long run.

If the price level did not remain constant when the government spending increases then

The change in total expenditures would be less than they would be if the price level remained constant.

The assumption that the price level is fixed in the Keynesian model allows

The multiplier to be fully applied.

Ricardian Equivalence Theorem

The proposition that an increase in the government budget deficit has no effect on aggregate demand. - Reason: people anticipate that a larger deficit today will mean higher taxes in the future and adjust their spending accordingly

Supply-side economics

The suggestion that creating incentives for individuals and firms to increase productivity will cause the aggregate supply curve to shift outward.

Crowding-out effect

The tendency of expansionary fiscal policy to cause a decrease in planned investment or planned consumption in the private sector. This decrease normally results from the rise in interest rates

Action Time Lag

The time required between recognizing an economic problem and implementing policy to solve it. The action time lag is quite long for fiscal policy, which requires congressional approval.

Government expenditures fund construction of high-rise office building on a plot of land where a private company otherwise would have constructed an essentially identical building. This is an example of

direct expenditure offsets to a fiscal policy action.

During normal times, discretionary fiscal policy

is probably not very effective in influencing real GDP.

The government provides a subsidy to help keep an existing firm operating, even though a group of investors otherwise would have provided a cash infusion that would have kept the company in business. This is an example of

Direct expenditures to a fiscal policy action.

Currently the government has a balance budget. It decided to follow an expansionary fiscal policy of reducing taxes by $100 billion. Which of the following statements bests describes the Ricardian equivalence Theorem under these conditions? The ricardian equivalence theorem implies that expansionary fiscal policy that creates a budget deficit will result in

Households save more than anticipated. No changes in aggregate demand.

When government spending increase, the change in total expenditures. when government spending decreases

Increased by more than the change in government spending. It decreases by more than the change in government spending.

Crowding out occurs when

Increases in government spending cause interest rates to rise, reducing investment and consumption.

Real wage = Nominal Wage/ Price Level.

nominal wage = 100/price level 10 = 10. what if it goes up by 5%? over time nominal wage will go up by 5 % . No change in the real wage. employers will not change the number of workers. no impact on labor. no change in output in the long run.

The assumption that the price level is fixed allows an increase in government spending to

show up exclusively as a rise in real GDP.

Gov't Spending multiplier = 1/MPS Government spending = Real GDP/Gov't spending Multiplier.

1/0.20 = 5 1/5 = 0.20 trillion

Refer to the figure at right. Suppose the economy is operating at paint A. There is a recessionary gap of ______, which can be closed by ________.

$2 trillion; expansionary fiscal policy that generates another $2 trillion in total spending.

The balanced budget multiplier is equal to ___.

1.

secular means

long term

Shift in the Aggregate demand curve.

*The supply of money. *Confidence *Real interest rates *Taxes-The value of the dollar.

Changes in government spending

- Military spending - Education spending - Budgets for government agencies

The AD curve is downward-sloping.

-The real-balances effect - P goes up. Decline in consumer spending. -The interest rate effect- As prices go up then we barrow more money to purchase. banks raise interest rates. reduces investment spending. -the open economy effect. if prices go up goods produced in other countries become cheaper. total demand for us goods and services will go down.

Suppose that the economy is presently operating at full employment. If there is a decrease in national income, which of the following will occur automatically?

A decrease in tax revenues.

Consider the following diagram in which the current short-run equilibrium is at point A. At point A, the economy has __________. If the marginal propensity to save equals 0.10, calculate the change in government spending that could eliminate the gap. $___ trillion.

A recessionary gap 0.10

The current situation would be described as a ______________. If the government wished to use discretionary fiscal policy to remedy this problem, it would need to ______ government spending. Show how the increase in government spending could be used to return the economy to full employment.

A recessionary gap. Increase.

The congressional meetings, discussions, arguments, debates over fiscal policy and the subsequent signing of vetoing by the president of a bill are part of the

Action time lag.

Direct Expenditure Offsets

Actions on the part of the private sector in spending income that offset government fiscal policy actions. Any increase in government spending in an area that competes with the private sector will have some direct expenditure offset.

You are a member of congress. The economy is currently experiencing a recessionary gap. which of the following are fiscal policies that Congress can enact in an attempt to correct the economy?

An increase in government spending and decrease in taxes.

Suppose that the economy is in short-run equilibrium but there is a recessionary gap. Which of the following is an example of discretionary fiscal policy that could be used to return the economy to full-employment real GDP?

An increase in government spending.

In early 2008, it appeared that the U.S economy was either in a recession or growing very slowly. President Bush announced a program of tax rebates. This program can be described as ___________ and was intended to ___________.

Discretionary fiscal policy; Increase consumer spending.

According to the supply side economists a(n) decrease in marginal tax rates will same for increase.

Either increase or decrease the amount of leisure time chosen by workers.

In the long run. Contracts _____. In the short run contracts are ____.

Expire. Fixed

LRAS measures

Full employment Real GDP. producing at our limit. Determined by our endowment of resources. Changes in the price level have no affect on AS. Vertical line.

One of the advantages of fiscal policy is that it

Generates a psyche of safety for consumers and investors because they know the government has the ability to use it.

Which of the following statements is correct?

Governments have a difficult time fine-tuning the economy by using fiscal policy because there are several time lags and these are often variable.

A progressive tax system s one in which the tax rates

Increase as income increases.

The proposition that an increase in the federal budget deficit caused entirely by a current tax cut has no effect on aggregate demand is called the

Ricardian equivalence theorem.

Economic growth is shown by _____.

Rightward shift of the LRAS curve.

Fiscal Policy

The discretionary changing of government expenditures or taxes in order to achieve national economic goals, such as: • High employment (low unemployment) • Price stability • Economic growth

Suppose that the economy is depicted by the following​ relationship: Expenditures​ = C​ + I​ + G​ + X ​where: C​ = $100​ + 0.80​(Y-​T) G​ = ​$700 T​ = ​$700 I​ = ​$100 X​ = ​$250

The economy is in equilibrium at a level of real GDP or income of ​$2250. (solve for Y) Y=100+0.80(Y-700)+100+700+250 Y=100+0.80(1150-700)+I+G+X Y=1150+0.80(Y) - 0.80 x 700 Y=1150+0.80(Y) - 560 Y=590+0.80(Y) Y=0.80(Y) = 590 (find the multiplier) 0.2(Y) = 5900 Y = 5 x 590 Y = 2950 -------------------------------------------------- Now suppose that the government decides to increase government spending by ​$100. What is the new equilibrium level of GDP or​ income? $2950 5 (multiplier) x $100 (spending) = $500 $2950 + $500 = $3450

Suppose that the economy is depicted by the following​ relationship: Expenditures​ = C​ + I​ + G​ + X ​where: C​ = $100​ + 0.80​(Y - ​T) G​ = ​$500 T​ = ​$500 I​ = ​$300 X​ = ​$150

The economy is in equilibrium at a level of real GDP or income of ​$3250. ------------------------------------------- Now suppose that the government decides to increase government spending by ​$50. What is the new equilibrium level of GDP or​ income? $3500

An increase in government spending shows up exclusively as a change in real GDP when

The price level is assumed to be constant.

Which of the following defines an effect time lag?

The time that elapses between the implementation of a policy and the results of a policy.

Appendix D: Fiscal Policy: A Keynesian Perspective

The traditional Keynesian approach to fiscal policy differs in three ways from that presented in Chapter 13: -It emphasizes the underpinnings of the components of aggregate demand. -It assumes that government expenditures are not substitutes for private expenditures and that current taxes are the only taxes taken into account by consumers and firms. -It focuses on the short run and so assumes that as a first approximation, the price level is constant.

How do automatic stabilizers work?

When a decline in national income occurs there will be a reduction in income tax collections and an increase in unemployment compensation and welfare payments muting the reduction in planned expenditures that would have otherwise resulted. increases government aid through welfare and unemployment compensations.

Fiscal policy is likely to be least effective

during normal economic times.

The time that elapses between the implementation of a policy and its intended result is referred to as.

the effect time lag

Given the existence of time lags, there is potential danger in using fiscal policy. Which of the following outcomes could occur because of the existence of such time lags?

-governments may undershoot the necessary change to gov spending or taxes to reach full GDP because they are uncertain what other factors may impact the economy. -governments ma overshoot the full employment real GDP as the economy has improved by the time the policy takes effect. -subsequent changes in the economy have caused the government to change its fiscal policy making it less consistent and the government less trustworthy.

Currently the government has a balanced budget. It decides to follow an expansionary fiscal policy of reducing taxes by​ $100 billion. Which of the following statements bests describes the Ricardian Equivalence Theorem under these​ conditions? A. Congress decreases government spending by an equivalent amount. B. Consumption rises and causes the aggregate supply to increase by the full effect of the multiplier. C. Households save more than anticipated. D. People figure that future generations will bear the burden of the tax increase and they themselves are not affected by the tax change. The Ricardian Equivalence Theorem implies that expansionary fiscal policy that creates a budget deficit will result in A. a long run increase in aggregate​ demand, but no immediate effect. B. no changes in aggregate demand. C. increases in increasing aggregate demand in both the short and long run. D. a short run increase in aggregate​ demand, but no change in the long run.

1) C. Households save more than anticipated. 2) B. no changes in aggregate demand.

Suppose that the economy is shown to the right. This economy is currently experiencing

A recessionary gap Since the short-run EQ is to the left of the LRAS curve.

Suppose that the economy Is depicted by the following relationship: C= $100 + .90(Y - T) G= $600 T = $600 I = $200 X= $250 Suppose that the government decides to increase government spending by $100 what is the new EQ of GDP income?

Expenditures = C + I + G + X Solve for Y Y = C + I + G + X Y= 100 + .90(Y - 600) + 200 + 600 + 250 Y=1150 + 0.90(Y)- - (0.90)(600) Y=1150 +0.90(Y) - 540 Y=610 + 0.90(Y) Y= 0.90(Y) = 610 0.10(Y) =610 Y=6100 multiplier is 1/MPS (1- .90 = .10) 1 __ = 10 .10 10 x 610 = 6100 Add $100 to G therefore the new income level is 7,100

Which of the following must be true if the balanced budget multiplier to equal one?

The increases in income stemming from a change in government spending must be greater than the change in income stemming from the change in taxes.

Fiscal policy is likely to be more effective

When the government borrowing does not increase interest rates substantially. when there are less offsetting reductions in private sector spending during abnormal times as opposed to more normal times.

The equilibrium real GDP is $13.00 trillion and full-employment EQ (FE) is 16.00 trillion. The marginal propensity is 0.30. Answer the questions using the data in the following graph.

a. Marginal propensity to consume: 1 - Marginal Propensity to save (MPS) since MPC + MPS = 1 MPC = 1- 0.30 = 0.70 Real GDP x MPS x 1000 = 3 x 0.30 x 1000 = 900 billion (calculated investment and spending increased) In order to convert the change in taxes from trillions of dollars to Billions of dollars, we need to multiply the expression by 1000. thus Real GDP x MPS ____________ x 1000 MPC = 3.00 x 0.30 ____________ x 1000 0.70 =$ 2396.71

Assume that MPX = 0.75, when answering the following questions. Calculate by how much the aggregate expenditure curve will shift. calculate the increase in EQ level of real GDP.

a. Suppose the government raises both taxes and government expenditures by 3 billion, calculate by how much the aggregate expenditure curve will shift. (1-0.75) x 3 =$ 0.75 billion b. By the same about... Increases in real GDP = Increase in government spending or increase in taxes = $ 3 billion. ****************

Suppose that the economy is shown to the right. This economy is currently experiencing

an inflationary gap. the fiscal policy correction is labeled D1

A rise in taxes

causes a reduction in aggregate demand because it can reduce consumption spending, investment expenditures, and net exports.

Increased government spending crowds out investment due to

higher interest rates.

Recognition Time Lag

The time required to gather information about the current state of the economy.

Effect Time Lag

The time that elapses between the implementation of a policy and the results of that policy.

Show the new equilibrium level of real GDP

The value of the autonomous spending multiplier is planned expenditures 16-4 _______________ = ________ = 0.50 real GDP 24-0 1 1 _______ = ____ = 2. (1 - 0.50 ) 0.50 Y = multiplier x G therefor the EQ GDP is $4 trillion

The U.S. government is in the midst of spending more than​ $1 billion on seven buildings containing more than​ 100,000 square feet of space to be used for study of infectious diseases. Prior to the​ government's decision to construct these​ buildings, a few universities had been planning to build essentially the same facilities using privately obtained funds. After construction on the government buildings​ began, however, the universities dropped their plans. The​ government's $1 billion expenditure will A. not push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because this expenditure would have been undertaken by universities. B. push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because there is a multiplier effect. C. push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because the universities dropped their plans. D. not push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because both the government and the universities would require borrowed funds.

A. not push U.S. real GDP above the level it would have reached in the absence of the​ government's construction spree because this expenditure would have been undertaken by universities.

When an economist is using the term "discretionary" as in discretionary spending, they are referring to the

Amount of government spending decided upon by congress or the government's ruling body.

A recession occurs, and government-funded unemployment compensation is paid to laid off workers. This is an example of

An automatic fiscal stabilizer

The laffer curve indicates

An inverse relationship between tax rates and tax revenues. a positive relationship between tax rates and tax revenues.

In the Keynesian model the amount of consumption is dependent on

Disposable income.

Fiscal Policy

The discretionary changing of government expenditures or taxes to achieve national economic goals, such as high employment with price stability.

a. A government agency arranges to make loans to businesses whenever an economic downturn begins. This is an example of __ _____ _____ _____. b. As the economy heats​ up, the resulting increase in equilibrium real GDP immediately results in higher income tax​ payments, which dampen consumption spending somewhat. This is an example of __ _____ _____ ______. c. As the economy starts to recover from a recession and more people go back to​ work, government funded unemployment compensation payments begin to decline. This is an example of __ _____ _____ _____. d. To stem an overheated​ economy, the​ President, using special powers granted by​ Congress, authorizes emergency impoundment of funds that Congress had previously authorized for spending on government programs. This is an example of __ _____ _____ _____.

a. an automatic fiscal stabilizer b. an automatic fiscal stabilizer c. an automatic fiscal stabilizer d. a discretionary fiscal policy

a. In an effort to help rejuvenate the​ nation's railroad​ system, a new government agency buys unused​ track, locomotives, and passenger and freight​ cars, many of which private companies would otherwise have purchased and put into regular use. This is an example of _____ _____ _____ to a fiscal policy action. b. The government increases its expenditures without raising​ taxes; to cover the resulting budget​ deficit, it issues more​ bonds, thereby pushing up the market interest rate and discouraging private planned investment spending. This is an example of_____ _____ _____ from a fiscal policy action. c. The government finances the construction of a classical music museum that otherwise never would have received private funding. This is an example of _____ __ _____ _____ ___ ___ _____ _____ __ _____ to a fiscal policy action.

a. direct expenditure offset b. indirect crowding out c. neither a direct expenditure nor an indirect crowding out offset

1) Which of the following statements is​ correct? A. Governments have a difficult time​ fine-tuning the economy by using fiscal policy because there are several time lags and these are often variable. B. Governments have a difficult time​ fine-tuning the economy by using fiscal policy because of the automatic stabilizers. C. Governments have the knowledge about how to​ fine-tune the​ economy, but the effect time lag generates a backlash from voters that makes it difficult to implement. D. Governments have learned how to use fiscal policy to​ fine-tune the economy. 2) Given the existence of time​ lags, there is potential danger in using fiscal policy. Which of the following outcomes could occur because of the existence of such time​ lags? A. Governments may overshoot the full employment real GDP as the economy has improved by the time the policy takes effect. B. Governments may undershoot the necessary change to government spending or taxes to reach full employment real GDP because they are uncertain what other factors may impact the economy. C. Subsequent changes in the economy have caused the government to change its fiscal policy making it less consistent and the government less trustworthy. D. Each of these scenarios are potential outcomes because of the existence of time lags.

1) A. Governments have a difficult time​ fine-tuning the economy by using fiscal policy because there are several time lags and these are often variable. 2) D. Each of these scenarios are potential outcomes because of the existence of time lags.

1) The Congressional​ meetings, discussions,​ arguments, debates over fiscal policy and the subsequent signing or vetoing by the President of a bill are part of the A. recognition time lag. B. political time lag. C. effect time lag. D. action time lag. 2) Which of the following statements is true when considering time​ lags? A. The effect time lag depends on the action of presidential economic advisors who will evaluate the effectiveness level of the fiscal policy. B. The shortest time lag is the action time lag since Congress has a set period to debate fiscal policy matters. C. Due to the fiscal policy variables​ (G and​ T) being flow​ variables, which are measured over a set​ period, time lags are confined to the same​ period, that is no longer than one year. D. Time lags in fiscal policy can be extremely long and may take several years before any impact is felt.

1) D. action time lag. 2) D. Time lags in fiscal policy can be extremely long and may take several years before any impact is felt.

The Laffer curve indicates A. an inverse relationship between tax rates and tax revenues. B. a positive relationship between tax rates and tax revenues. C. by how much the aggregate demand curve shifts when tax rates are changed. D. both options A and B. According to the supply side economists​ a(n) increase in marginal tax rates will A. increase the opportunity cost of leisure. B. increase aggregate demand . C. either increase or decrease the amount of leisure time chosen by workers. D. increase disposable income.

1) D. both options A and B. C. either increase or decrease the amount of leisure time chosen by workers.

The economy is depicted by the expenditures function as shown. Suppose that the government decided to decrease government spending by $2 trillion. Draw the new expenditure line after the decrease. Label the new EQ level of real GDP what is the autonomies spending multiplier ____?

4

Suppose that congress and the president decide that economic performance is weakening and that the government should" do something" about the situation. They make no tax changes but do enact new laws increasing government spending on variety of programs. Prior to the congressional and presidential actions, careful studies by government economists indicated that the direct effect of a rise in government expenditures on equilibrium real GPD Is equal to 6. In the 12 months since the increase in government spending, however, it has become clear that the actual ultimate effect on real GDP will be less than half of that amount. This could have happened because of all the following except.

A supply-side effect.

Suppose that the economy is presently operating at full employment. If there is an increase in national​ income, which of the following will occur​ automatically? A. An increase in tax revenues. B. An increase in tax rates. C. Upper A decrease in tax rates. D. An increase in unemployment compensation spending.

A. An increase in tax revenues.

suppose that the economy is shown to the right. This economy is currently experiencing _______. Draw and label the fiscal policy correction that would bring the economy to full employment GDP.

An inflationary gap

You are a member of Congress. The economy is currently experiencing a recessionary gap. Which of the following are fiscal policies that Congress can enact in an attempt to correct the​ economy? A. An increase in the money supply and a decrease in taxes. B. A decrease in government spending and an increase in taxes. C. An increase in government spending and a decrease in taxes. D. A decrease in the interest rate and an increase in the money supply.

C. An increase in government spending and a decrease in taxes.

One of the advantages of fiscal policy is that it A. is able to maintain a balanced budget for the government in the long run. B. is able to work extremely well in spite of the existence of time lags. C. generates a psyche of safety for consumers and investors because they know the government has the ability to use it. D. maintains the economy at full employment.

C. generates a psyche of safety for consumers and investors because they know the government has the ability to use it.

Example two of the above problem

C= 100 + .75 ( Y - T) C 100 G 700 T 700 I 100 X 150 *************MY STEPS******************** 100 + 700 + 100 + 150 = 1050 T = 700 x .75 = 525 1050-525 = 525 1 - .75 = .25 1 / .25 =4 525 * 4 = 2100 Real GDP = 2100 Add spending to $100 (G) Real GDP = 2500 Caution! when adding T!

In a​ recession, automatic stabilizers such as income transfer payments work by A. decreasing government spending and increasing taxes without requiring that a new policy be implemented. B. allowing Congress to implement new policies to reduce government spending and increase taxes. C. allowing Congress to implement new policies to increase government spending and reduce taxes. D. increasing government spending and reducing taxes without requiring that a new policy be implemented.

D. increasing government spending and reducing taxes without requiring that a new policy be implemented.

Suppose the economy is experiencing a recessionary gap at the current level of GDP. Which of the following fiscal policy actions would be most appropriate given the recessionary gap.

Decreasing taxes

Which of the following is not an automatic stabilizer

Defense spending.

When there is an economic downturn, congress and the president use fiscal policy to stabilize real GDP. But the conduct of the fiscal policy involves several time lags such as the recognition time lag that causes a delay in identification of the economic problem, the action time lag that is cause by the delay in congressional approval of the policy and the effect time lag that arises because policy actions take time to exert their full effect on the economy. These time lags could actually cause discretionary fiscal policy to

Destabilize real GDP because by the time a policy has begun to have its effects, the economy might already be recovering and the policy action might push real GDP up faster than intended, thereby making real GDP less stable.

In an effort to help rejuvenate the nation's railroad system, a new government agency buys unused track, locomotives, and passenger and freight cars, many of which private companies would otherwise have purchased and put into regular use. This is an example of _______________. The government increases it expenditures without raising taxes; to cover the resulting budget deficit, it issues more bonds, thereby pushing up the market interest rate and discouraging private planned investment spending. This is an example of _________________. The government finances the construction of a classical music museum that otherwise never would have received private funding. This is an example of ______________.

Direct expenditure offset to. Indirect crowing out from. Neither a direct expenditure nor an indirect crowing out offset to.

The US government decides to follow expansionary fiscal policy. Congress is meeting in late session on the last day before it breaks for vacation. One of the representatives makes a statement. "it does not matter what we spend the money on, let's just pass the bill and go home". Evaluate the accuracy of the representatives belief by choosing either the correct affirmation or rebuttal below. In the extreme case of direct expenditure offsets the

It does matter what the government decides to purchase with the additional spending. Increase in government expenditures are matched by a decrease in consumption.

The federal reserve decides to reduce the quantity of money in circulation in an effort to slow inflation. This is an example of

Monetary policy

Currently, a governments budget is balanced. The marginal propensity to consume is 0.75. The government has determined that each additional $10 billion in new government debt it issues to finance a budget deficit pushes up the market interest rate by .20 percent. it has also determined that every 0.10(on tenth) percentage change in the market interest rate generates a change in planned investment expenditures equal to $1 billion. finally, the government knows that to close a recessionary gap and take into account the resulting change in the price level, it must generate a net rightward shift in the aggregate demand curve equal to $250 billion My way to solve = .20% multiplied by 1 billion expenditure $= .20(mx) MPC = Marginal propensity to consume = 0.75 (MPC) 1 - 0.20- =.80 (1-mx) 1- .75 = .25 (1-MPC) .80 ______ = 3.2 which is the net multiplier 0.25 250/3.2 = 78.125 or 78.13 another example: .20 x 4 billion EX $ = .80 MPC= 0.80 1 - .80 = .20 1- .80 = .20 .20/.20 = 1 150/1= 150

Net change in spending of m = 0.20 X = 1 billion. (1-MX) = (1-0.20) = $0.80 We know that the AD curve will shift tot he right by the net change in spending multiplied by the multiple, which = 1/1- mpc (0.25) = 4 therefore , the net increase in AD due to the 1 billion increase in government expenditures is = 1-mx/1-mpx = 3.2 which is the net multiplier. To close the recessionary gap, government spending will have to increase by an amount equal to 250/3.2 = $

There are several time lags involved when fiscal policy is applied. The first hurdle faced by a government is

Recognizing that the economy is facing a problem that could be solved by applying fiscal policy.

Suppose that the economy is depicted by the following​ relationship: Expenditures​ = C​ + I​ + G​ + X ​where: C​ = $100​ + 0.75​(Y - ​T) G​ = ​$700 T​ = ​$700 I​ = ​$200 X​ = ​$250

The economy is in equilibrium at a level of real GDP or income of ​$2900. (solve for Y) Y=100+0.75(Y-700)+200+700+250 Y=100+0.75(1250-700)+I+G+X Y=1250+0.75(Y) - 0.75x700 Y=1250+0.75(Y) - 525 Y=725+0.75(Y) Y=0.75(Y)=725 (find the multiplier) 0.25(Y)=725 Y=4x725 Y=2900 -------------------------------------------------- Now suppose that the government decides to increase government spending by ​$100. What is the new equilibrium level of GDP or​ income? $3300 4(multiplier)x$100 (spending) = $400 $2900+$400=$3300

In may and June of 2008, the federal government issued one time-tax rebates-checks returning a small portion of taxes previously paid - to millions of u.s residents, and u.s real disposable income temporarily jumped by nearly $500 billion. however, household real consumption spending did not increase in response to the short-lived increase in real disposable income because. Which of the following economic theories can be used to account for this apparent non-relationship between real consumption and real disposable income in the late spring of 2008?

The one-time tax rebate failed to increase the recipients permanent income which determines an individuals current consumption. The permanent income hypothesis.

Suppose the government increases both taxes and government spending by the same amount, creating a balanced budget multiplier. If MPC increases, then

The value of the balanced-budget multiplier will not change.

Which of the following statements is true when considering time lags?

Time lags in fiscal policy can be extremely long and may take several years before an impact is felt.

If the Ricardian equivalence theorem is not relevant, then an income-tax-rate cut

Will result in a multiple times higher increase in equilibrium real GDP in the short run; however, a tax-rate reduction will reduce the automatic-stabilizer properties of the tax system, so equilibrium real GDP would be less stable.

Congress votes to fun a new jobs program designed to put unemployed workers to work. This is an example of

a discretionary fiscal policy.

Under powers authorized by an act of congress. the president decides to authorize an emergency release of funds for spending programs intended head off economic crises. This is an example of

a discretionary fiscal policy.

Assume that MPC = 0.60, consider the following a. If government expenditures rise by 1 billion, calculate by how much the aggregate expenditure curve will shift upward.

a. When government expenditures increases by 1 billion, the Aggregate expenditure or AE curve will shift up by an equal amount. AE1 = C + I + G1 AE2 = C+I+G2. The increase in AE2 -AE 1 = G2 - G1. The ******curve will shift upward by 1 billion.******* b. When taxes are raised by 1 billion, the aggregate expenditure or AE curve will shift downward by an amount that is equal to the initial increase in taxes time the MPC. AE = C + I + G = A + MPC ( Y - T) + I + G in other words *********MPC x Change in taxes = 0.60 x 1 = 0.6 *********

Consider the following diagram, in which the current short-run equilibrium is at point A. At point A, the economy has __________. If the marginal propensity to consume equals 0.8, to eliminate the gap, the government should decrease spending by ___________.

an inflationary gap. *******formula*** 1-0.8 = 0.20 1/0.2 = 5 inflation gap = 1.6 1.6 ___ = 0.32 trillion 5 0.32 Trillion!