MGEA06H3 Lecture Notes - Fiscal Policy, Reserve Requirement, Shortage

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lavenderdonkey6

30 Nov 2010

School

UTSC

Department

Economics for Management Studies

Course

MGEA06H3

Professor

Iris Au

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MGEA06H3 Full Course Notes

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Stabilization policy & the introduction of open economy. N discuss the effectiveness of monetary policy in affecting output. N compare how fiscal & monetary policies affect ad. N use of fiscal & monetary policies to smooth out business cycles. N discuss issues related to stabilization policy such as the crowding out effect and national debt. N monetary policy could be used to affect output: Introduce open economy in our model discuss the country"s balance of payments: to increase output the central bank should run expansionary monetary policy, to decrease output the central bank should run contractionary monetary policy. N answer: yes if the links hold up. For example, when ms increases, interest rate decreases: this decrease in interest rate would stimulate (physical) investment if firms and households were willing to invest. Investment increases ae increases ad increases y increases.

Related Questions

5. Fiscal policy is enacted through changes in

A. interest rates and the price level.

B. the supply of money and foreign exchange.

C. unemployment and inflation

D. taxation and government spending.

6. In an economy, the government wants to decrease aggregate demand by $48 billion at each price level to decrease real GDP and control demand-pull inflation. If the MPS is 0.25, then it could

A. increase taxes by $16 billion.

B. increase taxes by $24 billion.

C. decrease government spending by $10 billion.

D. decrease government spending by $16 billion.

7. If there is a constitutional requirement to maintain a balanced budget, then during a recession when tax revenues are shrinking, the government will have to implement

A. contractionary fiscal policy.

B. no change in fiscal policy.

C. expansionary fiscal policy.

D. countercyclical fiscal policy.

8. Most economists believe that fiscal policy is:

A. better than the monetary policy for "fine-tuning" the economy.

B. better than the monetary policy for month-to-month stabilization.

C. not as good as the monetary policy for month-to-month stabilization.

D. not very good at pushing the economy in a particular direction.

9. An increase in the legal reserve ratio

A. increases the money supply by increasing excess reserves

B. decreases the money supply by decreasing excess reserves

C. increases the money supply by decreasing excess reserves

D. decreases the money supply by increasing excess reserves

10. The discount rate is the rate of interest at which

A. Federal Reserve Banks lend to commercial banks

B. savings and loan associations lend to some builders

C. Federal Reserve Banks lend to large corporations.

D. commercial banks lend to large corporations

11. Which of the following actions by the Fed most likely increase commercial bank lending?

A. raising the reserve ratio

B. increasing the federal funds rate target

C. reducing the interest paid on excess reserves held at the Fed

D. selling bonds to commercial banks and the public

12. Assume the economy is operating at less than full employment. An expansionary monetary policy will cause interest rates to ______, which will ______ investment spending.

A. decrease; decrease

B. decrease; increase

C. increase; increase

D. increase; decrease

sapphirecrow883

MBA502, Economics for Business

Apply and Discover 7.2

You are responsible for economic policymaking in your country. Your desire is to eliminate inflation, keeping prices absolutely stable at P = 100, no matter what happens to output. Currently, the economy is in equilibrium at Q = 3200 (where Q = potential GDP) and P = 100. You can use monetary and fiscal policies to affect aggregate demand but you cannot affect aggregate supply in the short run. How would you respond to the following scenarios?

Explain and illustrate how each of these events would affect aggregate demand, aggregate supply, and prices, then explain how you would respond with economic policies.

1. A surprise increase in investment spending

In the short run, when investment spending increases, it results in an increase in Aggregate Demand (AD), which in turn pushes up both GPD and the price index.

To counterbalance this development, government might pursue contractionary fiscal policy by increasing taxes (to reduce consumption) or decreasing its own investment and spending so that the AD curve shifts back to its original position. Alternatively, the government can pursue contractionary monetary policy by reducing money supply and increasing interest rate to discourage economic activity.

2. Catastrophic floods that cause a sharp food price increase

In this case, sharp food shortages and consequent price increases cause a shock-type adjustment of the aggregate supply curve (it shift up and to the left). The result is a lower GDP and a higher price level.

The government cannot do anything to adjust AS in the short run. However, if the goal is to maintain the price level constant, the government can decide to do something to decrease the aggregate demand to force prices to come down, though it will be accompanies by another contraction in GDP and so it would not be a smart thing to do.

To cause AD to decrease, the government, similar to example above, can pursue fiscal policy (increase taxes, decrease spending) or monetary policy (reduce supply of money to the economy and thus increase interest rates).

3. A productivity decline that reduces potential output

In this case, AS shifts to the left, as was the case in example 2. As a result, price levels go up, as the same amount of money is chasing the reduced amount of goods and services, and GDP declines.

Government remedies here would be centered about causing AD to decrease through contractionary fiscal (higher taxes, lower spending) or monetary (reduce money supply and increase interest rates) policy. Again, this decision reduces inflation but at expense of GDP, as real output shrinks further.

4. A deep depression in East Asia that causes a sharp decrease in net exports to the United States

A decrease in exports of goods to from the United States to Asia will mean that the aggregate demand (which includes net exports

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Q38. The most effective means of stimulating the economy during a recession is for the federal government to
a. increase spending and hold taxes
b. hold government spending and decrease taxes
c. decrease government spending and hold taxes
d. decrease government spending and raise taxes

Q39. The tax rebate of 2008 is an example of
a. expansionary monetary policy
b. contractionary fiscal policy
c. contractionary monetary policy
d. pump priming

Q40. A decrease in the economy's capacity utilization rate
a. tends to decrease the unemployment rate
b. tends to increase the unemployment rate
c. has no impact on the unemployment rate
d. tends to have an unpredictable effect on the unemployment rate

Q41. When the federal budget is used as a tool for economic stabilization, the ideal goal is to
a. balance the budget over the entire business cycle
b. balance the budget each year
c. balance the budget during expansions
d. run a surplus during contractions

Q42. The gasoline tax is based on the principle of
a. cost of service
b. benefit received
c. ability to pay
d. equality of sacrifice

Q43. A loan is said to be productive if it
a. increases the purchasing power of the borrower
b. increases the present utility of the borrower's possessions
c. ultimately costs less to repay than it was worth when borrowed, due to inflation
d. increases the borrower's total output and profits

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MGEA06H3 Lecture Notes - Fiscal Policy, Reserve Requirement, Shortage

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