ECO 202 Chapter 16
Increased government debt can lead to higher interest rates and, as a result, crowding out of private investment spending. In terms of borrowing (debt-spending), what will offset the effect of crowding out in the long run so that government debt poses less of a problem to the economy?
- debt spending on education -debt spending on highways and ports -debt spending on research and development
Problem: Policy: Actions: Result: Recession Expan. inc gov spend Real GDP or ______ taxes & price_____ Rising Contract. _____________ spend Real GDP Inflation or inc taxes $ price ___
-decrease, rise -decrease govt spending, fall
Which of the following are categories of federal government expenditures?
-interest on the national debt -grants to state and local govts -transfer payments
Suppose the government increases expenditures by $120 billion and the marginal propensity to consume is 0.90. By how will equilibrium GDP change? The change in equilibrium GDP is: $_________
1200.0 billion
Which of the following is an example of an expansionary fiscal policy?
A decrease in taxes
The graph to the right illustrates the static AD-AS model. Suppose the economy is initially in long-run equilibrium at point A. The government decides to decrease government spending. In the short-run, this contractionary fiscal policy will cause:
A shift from AD 2 to AD 1 and a movement to point D, with a lower price level and lower output.
In the long run, government tax policy can affect private investment which impacts the production function and factors of production. In other words, aggregate supply may be impacted by different types of taxes the government can use. Which of the following is not true in terms of potential long run impacts of tax policies?
A tax rebate given one year will cause people to have more money and therefore they will spend more which will cause an increase in aggregate supply.
Which of the following is not a correct comparison between an expansionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?
A. If the economy is below full employment, expansionary fiscal policy will cause an increase in the price level in both models. B. In the dynamic model, expansionary policy would be used when demand does not grow sufficiently; in the basic model, expansionary policy would be used when demand falls. C. The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static.
The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model What would be the federal government's reaction if actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS 06? That is, what step can we expect the federal government to take to control inflation in the second period?
A. Increase taxes on businesses B. Contractionary policy C. Decreases government spending on goods and services
Suppose that at the same time Congress and the president pursue an expansionary fiscal policy, the Federal Reserve pursues an expansionary monetary policy. How might an expansionary monetary policy affect the extent of crowding out in the short run?
An expansionary monetary policy would decrease interest rates and thus reduce the extent of crowding out.
What is a contractionary fiscal policy?
Contractionary fiscal policy includes decreasing government spending and increasing taxes to decrease aggregate demand.
What is meant by crowding out?
Crowding out is a decline in private expenditures as a result of increases in government purchases. Your answer is correct.B.
The figure to the right illustrates the dynamic AD-AS model Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). We would expect the federal government to pursue what type of policy in order to move AD 2 to AD Subscript 2 comma policy and reach equilibrium (point C) in the second period? If the federal government's policy is successful, what is the effect on the following macroeconomic indicators? Actual real GDP: Potential real GDP: Price level: Unemployment:
Expansionary fiscal policy -increases -does not change -increases -decreases
What is an expansionary fiscal policy?
Expansionary fiscal policy includes increasing government spending and decreasing taxes to increase aggregate demand.
The multiplier effect is only a consideration for increases in government purchases.
False
What is fiscal policy?
Fiscal policy can be described as changes in interest rates to achieve macroeconomic policy objectives.
Suppose that the economy is currently at potential GDP, and the federal budget is balanced. If the economy moves into recession, what will happen to the federal budget?
If the budget is balanced at potential GDP and the economy moves into recession, then there will be a budget deficit as government expenditures increase and tax revenues decrease.
Which of the following best describes the difference between crowding out in the short run and in the long run?
In the short run, an increase in government purchases may not fully crowd out private expenditures due to the stimulative effect of an increase in government purchases on aggregate demand. In the long run, most economists believe that a permanent increase in government purchases will result in complete crowding out of private expenditures.
What changes should they make if they decide a contractionary fiscal policy is necessary?
In this case, Congress and the president should enact policies that decrease government spending and increase taxes. Your answer is correct.D.
If Congress and the president decide an expansionary fiscal policy is necessary, what changes should they make in government spending or taxes?
In this case, Congress and the president should enact policies that increase government spending and decrease taxes.
The figure to the right illustrates the dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). What policy would the federal government likely pursue in order to move AD 2 to AD Subscript 2 comma policy and reach equilibrium (point C) in the second period?
Increase government spending
The graph to the right shows a situation in which the economy was in equilibrium at potential GDP (at point A) when the demand for housing sharply declined. What actions can Congress and the president take to move the economy back to potential GDP?
Increase govt spending or decrease taxes
Which can be changed more quickly: monetary policy or fiscal policy?
Monetary policy can be changed more quickly than fiscal policy. Monetary policy can be changed at any of the FOMC meetings and the smaller number of individuals involved makes it easier to change policy.
What is the cyclically adjusted budget deficit or surplus?
The cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal government's budget if the economy were at potential GDP.
Who is responsible for fiscal policy?
The federal government controls fiscal policy.
If the short-run aggregate supply curve (SRAS) were a horizontal line, what would be the impact on the size of the government purchases and tax multipliers ?
The impact of the multiplier would be larger if the SRAS curve is horizontal.
Why might cutting government spending as a fiscal policy be a more difficult policy than the use of monetary policy to slow down an economy experiencing inflation?
The legislative process experiences longer delays than monetary policy.
When is it considered "good policy" for the government to run a budget deficit?
When borrowing is used for long-lived capital goods.
Does government spending ever reduce private spending?
Yes, due to crowding out
If the government cuts taxes in order to increase aggregate demand, the action is called
a discretionary fiscal policy.
President Trump was assuming that in 2017, the economy was
able to create more jobs and expand without increasing the inflation rate.
When actual GDP is below potential GDP the budget deficit increases because of:
an increase in transfer payments and a decrease in tax revenues.
Changes in taxes and spending that happen without actions by the government are called
automatic stabilizers
______________are spending by the government on goods, services, and factors of production. ______________ represent total government spending including goods, services, grants to state and local governments, and transfer payments. Since the 1950s, total government expenditures, as a percentage of GDP, have __________________ and total government purchases, as a percentage of GDP, have ___________ .
government purchases, government expenditures, increased, decreased
Assume the tax multiplier is estimated to be 1.4 and the aggregate supply curve has its usual upward slope. Suppose the government lowers taxes by $108 million. Aggregate demand will __________ by $______ million. (Enter your response rounded to one decimal place.)
increase, 151.2
Suppose the government increases expenditures while holding taxes the same. This will _______ deficits or _________ surpluses.
increase, decrease
The federal government would not want to increase its spending, even if the result were to increase real GDP and employment in the short run, if
it would lead to a greater federal deficit and an increase in the national debt.
The federal government's day-to-day activities include running federal agencies like the Environmental Protection Agency, the FBI, the National Park Service, and the Immigration and Customs Enforcement. Spending on these types of activities make up
less than 10 percent of federal government expenditures.
As a result of crowding out in the short run, the effect on real GDP of an increase in government spending is often
less than the increase in government spending.
In 2017, in proposing a $1 trillion increase in government spending on infrastructure, President Trump argued that the spending would increase total employment in the United States. Source: Ted Mann and Michael C. Bender, "President Trump to Launch Push for Infrastructure Investment," Wall Street Journal, June 4, 2017. In the short run, increases in federal spending will increase real GDP and employment if
the economy is producing at less than its potential output and has some cyclical unemployment.
The major cause of these trends is
there has been a major increase in the amount of transfer payments the government makes through programs such as Social Security and unemployment insurance.
The largest and fastest-growing category of federal government expenditures is
transfer payments
When the economy is experiencing a recession automatic stabilizers will cause:
transfer payments to increase and tax revenues to decrease.
