Chapter 16 - Quiz 4

Assume the tax multiplier is estimated to be 1.1 and the aggregate supply curve has its usual upward slope. Suppose the government lowers taxes by ​$58 million.

Aggregate demand will increase by ​$63.8 million 1.1 x 58 =63.8

Tax multiplier

= Change in equilibrium real GDP /Change in taxes

Government purchases multiplier=

Change in equilibrium real GDP/Change in government purchases. If, for​ example, the government purchases multiplier has a value of​ 2, an increase in government purchases of​ $100 billion should increase equilibrium real GDP by 2×​$100 billion=​$200 billion.

What is fiscal​ policy?

Fiscal policy can be described as changes in government spending and taxes to achieve macroeconomic policy objectives

A policy of decreasing the marginal income tax rate to increase labor supply is intended to result​ in:

Long run supply side effects

Multiplier effect

The series of induced increases in consumption spending that results from an initial increase in autonomous expenditures.

Some spending and taxes increase or decrease with the business cycle. This event often has an effect on the economy that is similar to fiscal policy and is called

automatic stabilizers.

If the government increases expenditure without raising​ taxes, this will

increase the budget deficit and require the government to borrow additional funds. cause the interest rate to​ increase, thereby, reducing private investment and crowding out the private sector.

The cyclically adjusted budget deficit is the deficit in the federal​ government's budget​ if:

the economy were at potential GDP.

When the economy is experiencing a recession automatic stabilizers will​ cause:

transfer payments to increase and tax revenues to decrease.

Suppose that real GDP is currently ​$13.33 trillion and potential real GDP is​ $14.0 trillion, or a gap of ​$700 billion. The government purchases multiplier is 5.0​, and the tax multiplier is 4.0.

Holding other factors​ constant, by how much will government purchases need to be increased to bring the economy to equilibrium at potential​ GDP? Government spending will need to be increased by ​$ 140billion. 700/5 = 140 Holding other factors​ constant, by how much will taxes have to be cut to bring the economy to equilibrium at potential​ GDP? Taxes will need to be cut by ​$175 billion 700/4 = 175

Suppose the government increases expenditures by ​$30 billion and the marginal propensity to consume is 0.90. By how will equilibrium GDP​ change?

The change in equilibrium GDP​ is: ​$300.0 billion. 30 / .10 = 300

Suppose the government increases taxes by ​$10 billion and the marginal propensity to consume is 0.80. By how will equilibrium GDP​ change?

The change in equilibrium GDP​ is: ​$−40.0 billion. ? .8 / .2 = 4 x 10 = 40

According to the multiplier effect ​, an initial increase in government purchases increases real GDP by _______ the initial increase in government purchases.

more than

Who is responsible for fiscal​ policy?

The federal government controls fiscal policy.

In​ 2009, Congress and the president enacted​ "cash for​ clunkers" legislation that paid people buying new cars up to​ $4,500 if they traded in an​ older, low​ gas-mileage car. Was this piece of legislation an example of fiscal​ policy?

Yes, because the primary goal of the spending program was to stimulate the national economy

Suppose the economy is initially in​ long-run equilibrium. The government enacts a policy to increase government spending. In the​ short-run, this expansionary fiscal policy will​ cause:

A shift from AD 1 to AD 2 and a movement to point​ B, with a higher price level and higher output.

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.

It is argued that a policy of tax simplification will result​ in:

A shift from LRAS1 to LRAS2 with higher output at a lower price level.

Change in GDP Change in government spending​

= Multiplier x Change in Government Spending = change in GDP​ / government purchases multiplier

Why might increasing taxes 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.