Macroeconomics 202 Midterm 2 Chapter 12

Causes that shift aggregate demand

- increase in aggregate supply leads to income increasing This tends to increase consumer and investment spending, shifting the aggregate demand curve to the right, but in any given period it may not shift the same amount as aggregate supply. -Government spends to pay for the ordinary business of government- items such as national defense, social security, and healthcare -Tax revenues, in part, pay for these expenditures. The result may be an increase in aggregate demand more than or less than the increase in aggregate supply. - Aggregate demand may fail to increase along with aggregate supply, or aggregate demand may even shift left, for a number of possible reasons: households become hesitant about consuming; firms decide against investing as much; or perhaps the demand from other countries for exports diminishes.

federal spending categories

national defense, Social Security, health programs, and interest payments -The share that the government has spent on national defense has generally declined, while the share it has spent on Social Security and on healthcare expenses (mainly Medicare and Medicaid) has increased. -government spending goes to four major areas: national defense, Social Security, healthcare, and interest payments on past borrowing. -it imposes an excise tax—that is, a tax on a particular good—on gasoline, tobacco, and alcohol -imposes an estate and gift tax on people who pass large amounts of assets to the next generation—either after death or during life in the form of gifts.

Outside Lag

once the government passes the bill it takes some time to disperse the funds to the appropriate agencies to implement the programs. the time it takes to start the projects the implementation lag or outside lag.

Fiscal policy

one of two policy tools for fine tuning the economy (the other is monetary policy). -Congress and the President make fiscal policy. -how federal government taxing and spending affects aggregate demand. - from a short-run perspective; that is, how government uses tax and spending policies to address recession, unemployment, and inflation; how periods of recession and growth affect government budgets; and the merits of balanced budget proposals. -is the set of policies that relate to federal government spending, taxation, and borrowing. - Fiscal policy can also contribute to pushing aggregate demand beyond potential GDP in a way that leads to inflation

discretionary spending programs

programs on the other hand can be changed by the administration on an annual basis (e.g., military spending) without changing a law and are thus easier to adjust.

government deficit (or surplus)

refers to what happens with the federal government budget each year.

The main revenue sources for state and local governments are

sales taxes, property taxes, and revenue passed along from the federal government, but many state and local governments also levy personal and corporate income taxes, as well as impose a wide variety of fees and charges.

contractionary fiscal policy.

shift aggregate demand inward (left) -does the reverse: it decreases the level of aggregate demand by decreasing consumption, decreasing investment, and decreasing government spending, either through cuts in government spending or increases in taxes -involving federal spending cuts or tax increases can help to reduce the upward pressure on the price level by shifting aggregate demand to the left, -most appropriate when an economy is producing above its potential GDP, or inflation-a rise in aggregate demand means that workers and firms throughout the economy earn more. Because taxes are based on personal income and corporate profits, a rise in aggregate demand automatically increases tax payments. -On the spending side, stronger aggregate demand typically means lower unemployment and fewer layoffs, and so there is less need for government spending on unemployment benefits, welfare, Medicaid, and other programs in the social safety net. -the central bank can also reduce or keep short-term interest rates low. Conversely, monetary policy can also help to ensure that contractionary fiscal policy does not lead to a recession.

During the 1930s, politicians did not use fiscal policy to counter the Great Depression because: the adherence to the gold standard prevented the necessary increase in the money supply. the Federal Reserve System opposed the idea. they feared the consequences of government budget deficits. they were concerned about the ensuing increase in interest rates.

Correct they feared the consequences of government budget deficits.

The permanent income view of consumption spending postulate when households receive a tax cut that is deemed temporary, then their consumption spending: will not change and the tax rebate is saved. will decrease. will increase by less than the tax cut. will increase by the full amount of the tax cut.

Correct will not change and the tax rebate is saved.

Monetary Policy

Federal Reserve make monetary policy shows us that a central bank can use its powers over the banking system to engage in countercyclical—or "against the business cycle"—actions. -If recession threatens, the central bank uses an expansionary monetary policy to increase the money supply, increase the quantity of loans, reduce interest rates, and shift aggregate demand to the right. -If inflation threatens, the central bank uses contractionary monetary policy to reduce the money supply, reduce the quantity of loans, raise interest rates, and shift aggregate demand to the left.

entitlement programs

Government benefits that certain qualified individuals are entitled to by law, regardless of need. -occurs without congressional or presidential action once the programs are established. -important entitlement programs are: Medicare (healthcare for the old), Medicaid (healthcare for the poor) and Social Security (pension payments to the old). -to change entitlement program spending, a law has to be passed.

Inside Lag

Many fiscal policy bills about spending or taxes propose changes that would start in the next budget year or would be phased in gradually over time. -refer to the time it takes to pass a bill as the legislative lag or inside lag.

progressive tax

The income tax is a progressive tax, which means that the tax rates increase as a household's income increases.ike the federal income tax, where those with higher incomes pay a higher share of taxes out of their income than those with lower incomes.

proportional tax

We also call the Medicare payroll tax a proportional tax; that is, a flat percentage of all wages earned. -he Social Security payroll tax is proportional up to the wage limit, like the payroll tax for Medicare, where everyone pays the same share of taxes regardless of income level.

budget deficit

a situation in which the government spends more than it takes in When the federal government spends more money than it receives in taxes in a given year -government borrows funds from U.S. citizens and foreigners to cover its budget deficits. It does this by selling securities (Treasury bonds, notes, and bills)—in essence borrowing from the public and promising to repay with interest in the future.

budget surplus

a situation in which the government takes in more than it spends -when the government receives more money in taxes than it spends in a year

government debt

accumulated over time. It is the sum of all past deficits and surpluses.

automatic stabilizers

changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action - Changes in tax and spending levels can also occur automatically -unemployment insurance and food stamps, which are programs that are already laws that stimulate aggregate demand in a recession and hold down aggregate demand in a potentially inflationary boom. -a rise in aggregate demand means that workers and firms throughout the economy earn more. Because taxes are based on personal income and corporate profits, a rise in aggregate demand automatically increases tax payments. -On the spending side, stronger aggregate demand typically means lower unemployment and fewer layoffs, and so there is less need for government spending on unemployment benefits, welfare, Medicaid, and other programs in the social safety net. -react to a weakening of aggregate demand with expansionary fiscal policy and react to a strengthening of aggregate demand with contractionary fiscal policy, just as the AD/AS analysis suggests -During recessions, the automatic stabilizers tend to increase the budget deficit -at full employment, the deficit would be reduced. - can be useful if they reduce the impact of the worst bumps, even if they do not eliminate the bumps altogether.

The length of time from when households receive tax rebate checks to the time they spend the checks is part of the: inside lag. outside lag. identification lag. inside-outside lag.

correct outside lag

regressive tax

meaning that people with higher incomes pay a smaller share of their income in tax. like the payroll tax (above a certain threshold) that supports Social Security, where those with high income pay a lower share of income in taxes than those with lower incomes.

balanced budget

Budget in which revenues are equal to spending -If government spending and taxes are equal, it has a balanced budget

the standardized employment budget

Congressional Budget Office (CBO) calculates -what the budget deficit or surplus would be if the economy were producing at potential GDP, where people who look for work were finding jobs in a reasonable period of time and businesses were making normal profits, with the result that both workers and businesses would be earning more and paying more taxes. - eliminates the impact of the automatic stabilizers - When the economy is in recession, the standardized employment budget deficit is less than the actual budget deficit because the economy is below potential GDP, and the automatic stabilizers are reducing taxes and increasing spending. -When the economy is performing extremely well, the standardized employment deficit (or surplus) is higher than the actual budget deficit (or surplus) because the economy is producing about potential GDP, so the automatic stabilizers are increasing taxes and reducing the need for government spending. -the calculation of what the budget deficit or budget surplus would have been in a given year if the economy had been producing at its potential GDP in that year.

In 2012, estates were taxed only if they exceeded a threshold of ________. $5 million $1 million $100 million $50 million

Correct $5 million

According to economic data, the last time the U.S. economy experienced a budget surplus was in: 2002. 2001. 2000. 1999.

Correct 2001.

The Kennedy administration endorsed substantial tax cuts because: tax rates were very high, compared to tax rates today. the economy was considered to be below its full employment level. the unemployment rate was considered to be above its natural rate. All of these

Correct All of these

Which of the following is not included in "Entitlement and mandatory spending"? : Defense Social Security Medicare Medicaid

Correct Defense

The federal corporate tax is levied on corporate revenue. True False

Correct False

A prolonged budget deficit when the economy is at full employment will eventually crowd out investment spending. True False

Correct True

According to the textbook, the Great Depression was prolonged due to the lack of net fiscal expansion. True False

Correct True

One reason why the U.S. government experienced a surplus during Clinton's era was that the U.S. economy was growing. True False

Correct True

The existence of lags in implementing fiscal policy can magnify economic fluctuations. True False

Correct True

A government policy action that moves the economy closer to full employment or potential output is called: an aggregate supply policy. an expansionary policy. a stabilization policy. a contractionary policy.

Correct a stabilization policy.

Because taxes and transfer payments such as unemployment insurance act to change GDP without the need for policymakers to take explicit action, then these taxes and transfer payments are called: automatic stabilizers. discretionary stabilizers. mandatory stabilizers. fluctuation stabilizers.

Correct automatic stabilizers.

Which of the following is an example of an expansionary fiscal policy? decreasing government spending less subsidies to encourage investment increasing taxes decreasing taxes

Correct decreasing taxes

According to the Laffer curve, higher tax rates will result in lower tax revenues if: economic activity is severely discouraged. only the rich are taxed. only the poor are taxed. workers are encouraged to work more hours.

Correct economic activity is severely discouraged.

As the population of the United States becomes older, which component of the Federal Spending would increase the most? entitlements and mandatory spending discretionary spending defense spending net interest

Correct entitlements and mandatory spending

Which of the following government policies is not considered a fiscal policy? government policies regarding the purchase of goods and services government policies regarding taxation government policies regarding money supply in the economy government policies regarding transfer payments and welfare benefits

Correct government policies regarding money supply in the economy

The tax cuts enacted during the first term of President Reagan were designed primarily to: decrease aggregate demand. increase aggregate demand. increase the supply of output. decrease the supply of output.

Correct increase the supply of output.

Using data from the 2011 fiscal year, federal income tax and social insurance tax revenues comprise ________ of total federal government revenues. over 80 percent less than 30 percent less than 75 percent over 60 percent

Correct over 80 percent

What kind of active fiscal policy was implemented in early 2008 in response to a slowing economy? tax rebates and investment incentives increased government spending on infrastructure decreased government spending on infrastructure increased tax rates to the rich aimed at closing the budget deficit

Correct tax rebates and investment incentives

Inside lags associated with fiscal policy are due to all of the following, except: the political infighting involved in approving changes in government spending or taxes. the poor and conflicting data available to policymakers. the delays in assessing the real state of the economy. the delayed response of the firms to a tax cut.

Correct the delayed response of the firms to a tax cut.

Which of the following did not cause the budget deficit to grow larger since 2001? the war in Iraq the fast growing economy since 2003 the tax cuts in 2001 and 2003 the larger in unemployment benefit claims in 2003

Correct the fast growing economy since 2003

expansionary fiscal policy

shifts the aggregate demand outward in the case(right) - increases the level of aggregate demand, through either increases in government spending or reductions in tax rates -Expansionary policy can do this by (1) increasing consumption by raising disposable income through cuts in personal income taxes or payroll taxes; (2) increasing investment spending by raising after-tax profits through cuts in business taxes; and (3) increasing government purchases through increased federal government spending on final goods and services and raising federal grants to state and local governments to increase their expenditures on final goods and services. - most appropriate when an economy is in recession and producing below its potential GDP. - if aggregate demand would fall to left bc recession, than some mix of tax cuts and spending increases - an expansionary fiscal policy intended to shift aggregate demand to the right can also lead to a higher interest rate, which has the effect of shifting aggregate demand back to the left.

entitlement and mandatory spending

spending that Congress has authorized by prior law, primarily providing support for individuals

Federal Taxes

the primary sources of federal taxes are individual income taxes and the payroll taxes that finance Social Security and Medicare. Corporate income taxes and social insurance taxes provide smaller shares of revenue. -The two main federal taxes are individual income taxes and payroll taxes that provide funds for Social Security and Medicare; these taxes together account for more than 80% of federal revenues. -Other federal taxes include the corporate income tax, excise taxes on alcohol, gasoline and tobacco, and the estate and gift tax.

crowding out

where government borrowing and spending results in higher interest rates, which reduces business investment and household consumption.

balanced budget laws

which means any gaps between revenues and spending must be closed by higher taxes, lower spending, drawing down their previous savings, or some combination of all of these. - is state gov

discretionary fiscal policy

which occurs when the government enacts taxation or spending changes in response to economic events, or through automatic stabilizers, which are taxing and spending mechanisms that, by their design, shift in response to economic events without any further legislation.