Economoics Chapter 13

A government is currently operating with an annual budget deficit of $40 billion. The government has determined that every $10 billion reduction in the amount of bonds it issues each year would reduce the market interest rate by 0.10 percentage point. Furthermore, it has determined that every 0.10 (one-tenth) percentage point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to $4 billion. The marginal propensity to consume is 0.75. Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to $60 billion. Assuming there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes?

$42.86 billion

The balanced budget multiplier is equal to

1

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 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?

A decrease in government spending and an increase in taxes.

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

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

A discretionary fiscal policy

To stem an overhead 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 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

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

A monetary policy

Prior to the congressional and presidential actions, careful studies by government economists indicated that the direct multiplier effect of a rise in government expenditures on equilibrium real GDP 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

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

Action time lag

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 government agency arranges to make loans to businesses whenever an economic downturn begins. This is an example of

An automatic fiscal stabilizer

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

An automatic fiscal stabilizer

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

An automatic fiscal stabilizer

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

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

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, 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 that exception?

Automatic Stabilizers

The purpose of automatic stabilizers is to

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

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 caused 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 effects 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

Direct expenditure offset to

Government expenditures fund construction of a 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_______ a fiscal policy action.

Direct expenditure offsets to

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 _________ a fiscal policy action.

Direct expenditure offsets to

Fiscal policy refers to

Discretionary changes in government spending and taxes

Fiscal policy is likely to be more effective

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

Fiscal policy is likely to be least effective

During normal economic times

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?

Each of these scenarios are potential outcomes because of the existence of time lags

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 won't 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

According the the supply side economists a decrease in marginal tax rates will

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

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

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

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.

Increased government spending crowds out investment due to

Higher interest rates

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?

Households save more than anticipated

Suppose that Congress enacts a lump-sum tax cut of $750 billion. The marginal propensity to consume is equal to 0.75.

If Ricardian equivalence holds true, equilibrium real GDP will REMAIN UNCHANGED. If Ricardian equivalence holds true, savings will INCREASE BY THE AMOUNT OF THE TAX CUT.

A progressive tax system is one in which the tax rates

Increase as income increases

In the extreme case of direct expenditure offsets the

Increase in government expenditures are matched by a decrease in consumption

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 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

Indirect crowding out from

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_________ a fiscal policy action.

Indirect crowding out from

The government finances the construction of a classical music museum that otherwise never would have received private funding. This is an EXAMPLE of

Neither direct expenditure nor an indirect crowding out offset to; a fiscal policy action.

The Ricardian Equivalence Theorem implies that expansionary fiscal policy that creates a budget deficit will result in

No changes in aggregate demand

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 governments $1 billion expenditure will

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.

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

Show up exclusively as a rise in real GDP

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

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

C+I+G+X C=$100+0.80Y(Y-T) G=$700 T=$700 I=$100 X=$250

The economy in in equilibrium at a level of real GDP or income of ($2950) Now suppose that the government decides to increase government spending by $125. What is the new equilibrium level of GDP or income? ($3575)

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

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

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

The multiplier effect to be fully applied

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

The one-time tax rebate failed to increase the recipients' permanent income which determines an individual's currents consumption

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 permanent income hypothesis

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 a recognition time lag?

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

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

The workings of automatic stabilizers

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 any impact is felt

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

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

Will result in a multiplier times higher decrease 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

Which of the following is an example of discretionary fiscal policy that could be used to return the economy to full-employment REAL GDP?

a decrease in government spending

The Ricardian Equivalence theorem states that

an increase in the government budget deficit has no effect on aggregate demand.

Automatic stabilizers

cause changes in the economy without the action of Congress and the President

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

In the Keynesian model the amount of consumption is dependent on

disposable income

Crowding out occurs when

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

In a recession, automatic stabilizers such as the tax system work by

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

During normal economic times, when there is not "excessive" unemployment or inflation, discretionary fiscal policy

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

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.