InQuizitive Chapter 16: Fiscal Policy

A worker gets a raise of $120 per month and quickly decides to spend $90 of the money on necessities and the occasional luxury, while putting the remaining $30 into retirement savings. Based on this decision, calculate the worker's marginal propensity to consume, or MPC, as a decimal.

0.75

Page 54816.2. What are the shortcomings of fiscal policy? Suppose the government has a balanced budget and wants to increase spending without changing tax rates. The government enters the loanable funds market to borrow $150 billion for economic stimulus spending. How much money is available for private investment after this action has shifted the demand curve as shown in the figure?

250 billion dollars

If the marginal propensity to consume is 0.80, what is the total implied increase in economic spending activity from a government stimulus of $100 billion?

500 Billion

Classify each scenario according to the type of policy lag it illustrates.

A bill proposing a tax cut is held up in Congress by a filibuster. Correct label: implementation lag The economy trends downward for two months, but economists are not sure if this signals the start of a recession. Correct label: recognition lag Government spending is cut by $100 billion, but inflation persists for another 12 months. Correct label: impact lag Congress passes an immediate tax cut for all citizens, but it is another 24 months before GDP starts to climb once again. Correct label: impact lag Congress approves a $100 million spending package, but officials need six months to determine which projects to finance. Correct label: implementation lag Economists determine that unemployment has skyrocketed several months after it began to rise. Correct label: recognition lag

Place the events in sequence to describe how crowding-out happens.

Because of a recession, consumers have less disposable income to spend on durable goods, like cars. A state government passes a stimulus package that sends aid to struggling car manufacturing firm in the state. Car manufacturers use government funding, instead of their own money, to invest in improving their machinery. Despite the increase in spending, aggregate demand has not increased as much as expected.

What is the reasoning behind the multiplying effect of government spending?

Every dollar spent is paid to someone who will turn around and spend a portion of it.

Government borrowing to fund economy-boosting projects is self-defeating, since crowding-out will completely cancel out the benefits of the policy.

False

Automatic stabilizers are government programs that automatically implement countercyclical fiscal policy in response to economic conditions. Match each automatic stabilizer to its description given that the economy is experiencing recession.

Firms' profit plunges. Correct label: taxes on corporate profits Lower wages and salaries are paid to individuals. Correct label: progressive income tax rates Chrystal is laid off her job. Correct label: unemployment compensation Megan, a single mother, enrolls in a Medicaid program because her job lowered her wages and she has no health insurance for her children. Correct label: welfare programs

Match the following fiscal policy shortcomings with their corresponding results.

Government spending can serve as a substitute for private spending. Correct label: crowding-out The effects of fiscal policy may be delayed by lags in recognition, implementation, and impact. Correct label: time lags In response to increases in government spending or lower taxes, people may increase their current savings to help pay for inevitably higher future taxes. Correct label: saving shifts

What was the centerpiece action of the Economic Stimulus Act of 2008?

It gave American taxpayers a partial rebate.

GDP is composed of four main categories. Which of those categories are the primary target of fiscal policy?

Primary Targets: government spending consumption spending

Which policy tools are not considered automatic stabilizers?

Social Security economic stimulus legislation

Apply the correct description to each policy example.

The government postpones funding for upgrades to the nation's railway system. Correct label: contractionary The government orders the construction of two new aircraft carriers. Correct label: expansionary Congress passes a 5% decrease in marginal tax rates. Correct label: expansionary The government raises the top marginal income tax rate. Correct label: contractionary

There are times when the government wants to slow down economic growth.

True

Which of the following is typically the target of fiscal policy?

aggregate demand

The economy's output, real GDP, has drastically dropped. What are the possible fiscal policy solutions to return the real GDP to its higher production level?

decrease taxes increase government spending

What are not the tools employed by the government to adjust market conditions?

decrease unemployment lower prices

Expansionary fiscal policy used during economic downturns inevitably leads to a budget deficit. Suppose the government responds to the downturn by increasing government spending by $250 billion, but keeps tax rates the same. In this scenario, the deficit will rise by more than $250 billion. In a recession, income falls and unemployment rises, which means tax revenues will fall even if tax rates do not change.

deficit deficit more than income unemployment fall

The use of - to counteract economic - leads to greater budget deficits. During recessions, - falls, which reduces the funding source for - . Consequently, the government takes on debt to thrust the economy out of recession.

expansionary downturns tax revenue government spending

What is the definition of supply-side fiscal policy?

fiscal policy aimed at impacting long-run aggregate supply rather than aggregate demand

Ripple effects occur throughout the economy when - increases. To determine the effects of this increase, the - is used to calculate the -, which tells us the total impact on - .

government spending marginal propensity to consume (MPC) spending multiplier consumer spending

Identify each policy action as being focused on the demand side, the supply side, or both.

government-funded scholarships for college students Correct label: supply side decreasing income tax rates Correct label: demand side research grants for a corporation developing new technologies Correct label: supply side lowering income tax rates at all income levels Correct label: both stimulus packages for firms that are "too big to fail" Correct label: demand side

The economy's output, real GDP, has drastically dropped. What are not the possible fiscal policy solutions to return the real GDP to its higher production level?

increase taxes decrease unemployment

What are not the causes of rising government budget deficits when expansionary fiscal policy is used during recessions?

increased borrowing by private entities higher income tax rates

Label each example of fiscal policy initiated during the COVID-19 recession as either supply-side or demand-side.

increasing unemployment compensation by $600 Correct label: demand-side fiscal policy providing tax rebate checks for eligible U.S. taxpayers Correct label: demand-side fiscal policy instituting the Paycheck Protection Program (PPP) Correct label: supply-side fiscal policy providing loans and aid to airlines, hospitals, and other large businesses Correct label: supply-side fiscal policy

GDP is composed of four main categories. Which of those categories are NOT the primary target of fiscal policy?

net exports investment technology

The first fiscal response in 2020 was - than other stimulus packages from previous recessions. This was partially because there was virtually no - , as the World Health Organization declared COVID-19 a global pandemic and so the cause of the recession was well understood.

quicker recognition

What are the causes of rising government budget deficits when expansionary fiscal policy is used during recessions?

reduced economic activity, which means less tax revenue increased government borrowing

The purpose of fiscal policy is to - variations that accompany the - . However, it is sometimes difficult to identify what type of variation the economy is experiencing due to the lack of real-time data; this is known as _ . Secondly, the process of approval by the governing body causes - . Lastly, it requires time for the policy to take effect in the economy; this is called -.

smooth out business cycle recognition lag implementation lag impact lag

John F. Kennedy was endorsing - fiscal policy when he declared that lowering the top marginal income tax rate, then at -, would not only be - but also lead to more government revenue.

supply-side 91% ex[ansionary

The Laffer curve models tax revenue as a function of a single tax rate. In a progressive scheme, one has to look separately at the revenue from different segments of taxpayers, corresponding to different rates. The data in the table suggests that tax cuts in the early 1980s led to less revenue from lower-income taxpayers but more revenue from the highest-income taxpayers. This would mean that reductions in the top marginal rate, at least, made fiscal sense.

tax revenue tax rate less more top marginal

What are the tools employed by the government to adjust market conditions?

taxes government spending

Supply-side policy aims to shift the aggregate supply curve not just temporarily but permanently.

true

Which policy tools are considered automatic stabilizers?

welfare programs a progressive income tax structure taxes on corporate profits government unemployment benefits