Macro - Chapter 16

Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals 0.60​, calculate the value of the following multipliers. Be sure to use a negative sign​ (-) to show if a multiplier has a negative value. The tax multiplier equals

-1.5 tax multiplier = { (-MPC)/(1-MPC) }

Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals 0.60​, calculate the value of the following multipliers. Be sure to use a negative sign​ (-) to show if a multiplier has a negative value. The balanced budget multiplier equals

1 The value of the balanced budget multiplier is always​ 1, meaning that if government purchases and taxes BOTH change by the same amount​ (and in the same​ direction) then equilibrium GDP will change in exactly the same way.

Contractionary fiscal​ policy:

1. Increasing taxes on individuals and businesses 2. Decreasing government spending on goods and services

In the dynamic​ AD-AS model we​ assume:

1. The economy experiences inflation​ and, 2. the economy experiences long run growth. That​ is, the LRAS curve shifts to the right each year. In​ addition, the AD and the SRAS curves also shift to the right each year.

Similarly, explain why a decrease in the marginal propensity to import would increase the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier the denominator is

1− ​[MPC×​(1 −​t)− ​MPI]

If the marginal propensity to consume equals 0.80​, the tax rate equals 0.20​, and the marginal propensity to import equals 0.05​, what is the value of the government purchases​ multiplier? The government purchases multiplier is equal to

2.44 The government purchases multiplier is 1 divided by [ 1 - (MPC(1-t) - MPI)

Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals 0.60​, calculate the value of the following multipliers. Be sure to use a negative sign​ (-) to show if a multiplier has a negative value. The government purchases multiplier equals

2.5 The government purchases multiplier divide 1 by (1- MPC)

Crowding out

A decline in private expenditures as a result of an increase in government purchases.

How does a budget deficit act as an automatic stabilizer and reduce the severity of a​ recession?

A. Transfer payments to households increase. B. Consumers spend more than they would in the absence of social insurance​ programs, like unemployment. C. During​ recessions, tax obligations fall due to falling wages and profits. D. All of the above.

Aggregate Demand and Aggregate Supply Model

An extension of the basic​ AD-AS model that introduces the following​ conditions: 1. The economy experiences continuing​ inflation, with the price level rising every year. 2. The economy experiences​ long-run economic​ growth, with the LRAS curve shifting to the right every year.

Fiscal Policy

Changes in federal taxes and purchases that are intended to achieve macroeconomic policy​ objectives, such as high​ employment, price​ stability, and high rates of economic growth.

Corporate income tax

Cutting the corporate income tax can increase the return to investment and innovation and can increase the pace of technological change.

Individual income tax.

Cutting the individual income tax reduces the tax wedge and increases the quantity of labor supplied. In​ addition, it increases the returns to saving and the return to entrepreneurship.

What is the difference between federal government purchases​ (spending) and federal government​ expenditures?

Government purchases are included in government expenditures.

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 AD2 to AD Subscript 2 comma policy AD2, policy and reach equilibrium​ (point C) in the second​ period?

Increase government spending

Consider the figure to the right. An increase in government spending shifted the aggregate demand curve from AD1 to AD2. As a​ result, both price level and real GDP increased. What can be​ said, however, about the increase in real​ GDP?

It increased by less than indicated by a multiplier with a constant price level.

Capital gains and dividends taxes

Lowering taxes on capital gains and dividends paid to stockholders increases the supply of loanable funds and increases saving and investment. It also lowers the equilibrium real interest rate.

After September​ 11, 2001, the federal government increased military spending on wars in Iraq and Afghanistan. Is this increase in spending considered fiscal​ policy?

No. The increase in defense spending after that date was designed to achieve homeland security objectives.

Current​ income:

Reflects​ consumers' current disposable income.

Permanent​ income:

Reflects​ consumers' expected future income.

Tax wedge

The difference between the pretax and the posttax return to an economic activity.

Budget deficit

The situation in which the​ government's expenditures are greater than its tax revenue.

Budget surplus

The situation in which the​ government's expenditures are less than its tax revenue.

Liquidity​ constrained:

The spending of this type of consumer is more likely to depend on their current income.

If Congress passed a​ one-time tax cut in order to stimulate the economy in​ 2014, and tax rate levels returned to their​ pre-tax 2014 level in​ 2015, how should this tax cut affect the​ economy?

The tax cut would increase consumption spending less than would a permanent tax cut.

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.

One-time tax​ rebates, such as those in 2001 and​ 2008, increase consumption spending by less than a permanent tax cut because​ one-time tax rebates increase

current​ income

Contractionary fiscal policy involves

decreasing government purchases or increasing taxes. Decreasing government purchases decreases aggregate demand directly because government purchases are a component of aggregate demand. Increasing taxes decreases disposable income​ which, in​ turn, decreases consumption by households and firms.

Expansionary fiscal policy involves

increasing government purchases or decreasing taxes. Increasing government purchases increases aggregate demand directly because government purchases are a component of aggregate demand. Decreasing taxes increases disposable income​ which, in​ turn, increases consumption by households and firms.

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.

Suppose real GDP is​ $12.1 trillion and potential GDP is​ $12.6 trillion. To move the economy back to potential​ GDP, Congress should

lower taxes by an amount less than​ $500 billion.

If government purchases increase by​ $100 billion and lead to an ultimate increase in aggregate demand as shown in the graph to the​ right, the difference in real GDP between point A and point B will be

more than​ $100 billion.

Policy that is specifically designed to affect aggregate supply and increase incentives to​ work, save, and start a​ business, by reducing the tax wedge is called

supply-side economics.

From an understanding of the multiplier​ process, explain why an increase in the tax rate would decrease the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier

the MPC is multiplied by​ (1− ​t).

What are the gains to be had from simplifying the tax​ code?

A. Greater clarity of the decisions made by households and firms. B. Resources from the tax preparation industry freed up for other endeavors. C. Increased efficiency of households and firms. D. All of the above.

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?

A. ​Debt-spending on education. B. ​Debt-spending on research and development. C. ​Debt-spending on highways and ports. D. All of the above.

Budget deficits occur automatically during recessions for two reasons.​

First, tax revenues fall due to falling wages and profits.​ Second, spending on transfer​ payments, such as unemployment​ insurance, increases.