ECON 1BB3 Chapter Notes - Chapter 12: Purch Group, Deflation, Business Cycle

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viridianmarten541

26 Apr 2018

School

McMaster University

Department

Economics

Course

ECON 1BB3

Professor

Bridget O' Shaughnessy

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Chapter 11: Fiscal Policy

Fiscal Policy: focuses on the effects of taxing and public spending on aggregate economic

activity

Automatic Stabilizers: structural features of government spending and taxation that reduce

fluctuations in disposable income, and thus consumption, over the business cycle

 Revenue and spending programs in the fed budget that automatically adjust the economy

to stabilize disposable income, consumption and real GDP

Federal Income Tax as an Automatic Stabilizer:

 Once adopted, it requires no parliamentary action to operate (it’s automatic)

 It reduces the drop in disposable income during recessions and the jump in disposable

income during expansions (it’s a stabilizer)

Discretionary Fiscal Policy: the deliberate manipulation of government purchases, taxation, and

other transfer payments to promote macroeconomic goals (ex. full employment, price stability,

and economic growth)

 Ex. one-time tax cuts or government spending increases to fight a recession

→ At any given price level, an increase in government purchases or transfer payments increases

real GDP demanded, and an increases in net taxes decreases real GDP demanded, other things

constant

→ Government Purchases = Net Taxes, both are autonomous

→ Graph shows that fed policy makers believe that unemployment is too high, decide to

stimulate AD by increasing gov. purch. by $10 billion

→ additional spending shifts AD upward by $10 bill, spending now exceeds output, so

production increases, increasing income

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→ As long as consumption is the only spending component that varies with income, the

multiplier for a change in government purchases = 1 / (1 - MPC)

→ Decrease in Net Taxes = increase in Disposable Income

→ Consumption spending at each level of real GDP rises by the decreases in net taxes multiplied

by the MPC

Simple Tax Multiplier: the ratio of change in real GDP demanded to the initial change in

autonomous net taxes that brought it about

Expansionary Fiscal Policy: increase in government purchases, decreases in net taxes, or some

combo aimed at increasing AD enough to reduce unemployment and return the economy to its

potential output; fiscal policy used to close a recessionary gap

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ECON 1BB3 Full Course Notes

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Document Summary

Fiscal policy: focuses on the effects of taxing and public spending on aggregate economic activity. Automatic stabilizers: structural features of government spending and taxation that reduce fluctuations in disposable income, and thus consumption, over the business cycle. Revenue and spending programs in the fed budget that automatically adjust the economy to stabilize disposable income, consumption and real gdp. Once adopted, it requires no parliamentary action to operate (it"s automatic) It reduces the drop in disposable income during recessions and the jump in disposable income during expansions (it"s a stabilizer) Discretionary fiscal policy: the deliberate manipulation of government purchases, taxation, and other transfer payments to promote macroeconomic goals (ex. full employment, price stability, and economic growth) Ex. one-time tax cuts or government spending increases to fight a recession. At any given price level, an increase in government purchases or transfer payments increases real gdp demanded, and an increases in net taxes decreases real gdp demanded, other things constant.

Related Questions

1.Ceteris paribus, if the U.S. federal government reduces its budget deficit which of the following will be observed?

Answer

	a.	The aggregate demand curve will shift to the right.
	b.	The economy will always approach potential GDP.
	c.	The marginal propensity to consume will increase.
	d.	The average price level will increase.
	e.	The aggregate demand curve will shift to the left.

2. If the government wants to close a GDP gap, it can:

Answer

	a.	lower government spending on social security.
	b.	adopt contractionary fiscal policies to control inflation.
	c.	increase its budget deficit.
	d.	repay its borrowings.
	e.	raise both direct and indirect tax rates.

3. Suppose the short-run equilibrium level of income exceeds the full employment level of income and there is high inflation. Hence, the government decides to implement a fiscal policy that will act to reduce national output and price level. This can be accomplished by:

Answer

	a.	lowering average tax rates such that aggregate supply is increased.
	b.	increasing government spending such that aggregate expenditures are increased.
	c.	increasing transfer payments such that aggregate expenditures decline.
	d.	raising taxes and government spending by the same amount such that aggregate supply is decreased and aggregate demand is increased.
	e.	decreasing government spending such that aggregate demand is reduced.

4. A drop in investment spending caused by increased government budget deficits is referred to as:

Answer

	a.	the multiplier effect.
	b.	crowding out.
	c.	an expansionary gap.
	d.	the paradox of thrift.
	e.	the Ricardian equivalence.

5. Discretionary fiscal policy is best defined as:

Answer

	a.	the deliberate manipulation of the money supply to expand the economy.
	b.	the deliberate change in tax laws and government spending to change equilibrium income.
	c.	the policy action taken by the Congress to reduce the federal budget deficit.
	d.	the arbitrary fluctuation in tax laws and budget requirements.
	e.	the automatic change in certain fiscal instruments when real GDP changes.

6. Which of the following can be considered as an automatic stabilizer in the economy?

Answer

	a.	Money supply
	b.	Disposable income
	c.	Real exchange rate
	d.	Real interest rate
	e.	Unemployment insurance

7. Which of the following is true about automatic stabilizers?

Answer

	a.	When income rises, automatic stabilizers increase/boost spending.
	b.	Automatic stabilizers are a part of discretionary fiscal policy.
	c.	An automatic stabilizer is any program that responds to fluctuations in the business cycle in a way that moderates the effects of those fluctuations.
	d.	Any kind of trade policy adopted by the government will be considered as an automatic stabilizer.
	e.	The interest rate is an example of an automatic stabilizer.

8. Increased budget deficits

Answer

	a.	can cause interest rates to increase and hence decrease net exports
	b.	have no effect on net exports
	c.	can cause interest rates to decrease and hence increase net exports
	d.	never impose additional interest costs on the government

9. The Ricadian Equivalence implies that when financing additional government expenditures

Answer

	a.	there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will decrease either way.
	b.	there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will increase either way.
	c.	increasing borrowing is the best option
	d.	increasing current taxes is the best option

10. Assuming no effects on aggregate supply, if the government increases government spending and decreases taxes in an attempt to prevent a possible recession, aggregate demand will shift to the ____, the price level will either remain constant or ____, and the level of real GDP will ____.

Answer

	a.	right; decrease; increase
	b.	right; decrease; decrease
	c.	left; decrease; decrease
	d.	left; increase; increase
	e.	right; increase; increase

11. For a hypothetical economy, the MPS is 0.08 and the MPI is 0.17. If government spending increases by $35 and taxes increase by $35, what will be the net effect on equilibrium income?

Answer

	a.	A decrease of $35
	b.	An increase of $105
	c.	An increase of $35
	d.	A decrease of $105
	e.	A decrease of $15

12.12. The term fiscal policy refers to

Answer

	a.	the adjustment of the GDP for inflation.
	b.	the purchase and sale of U.S. government securities to regulate the money supply.
	c.	the use of government spending and taxation to influence the level of economic growth and inflation.
	d.	the use of fines to penalize unfair business practices.
	e.	a policy action by Congress to overrule unpopular budget cuts by the president.

13. If aggregate demand intersects aggregate supply in the vertical range of the aggregate supply curve, then, other things equal, an increase in government spending will

Answer

	a.	raise the price level and leave real GDP unchanged.
	b.	raise real GDP by the amount indicated by the government spending multiplier and leave the price level unchanged.
	c.	raise both real GDP and the price level by a multiple of the initial spending increase.
	d.	have no effect on real GDP or on the price level, because all private investment will be crowded out.
	e.	lower real GDP by an amount equal to the spending increase and reduce inflation.

14. Which of the following is not a means to finance government spending?

Answer

	a.	Government subsidies
	b.	Government debt
	c.	Capital gains taxes
	d.	Personal income taxes
	e.	Money creation

15. An automatic stabilizer is

Answer

	a.	a change in government spending aimed at achieving a policy goal.
	b.	an element of fiscal policy that automatically changes in value as real GDP changes.
	c.	an element of monetary policy that automatically changes in value as real GDP changes.
	d.	a decrease in tax rates as the economy moves into a recession.
	e.	a deliberate change in taxation aimed at increasing real GDP.

16. Budget deficits tend to grow during recessions because

Answer

	a.	real GDP growth is zero, which causes neither tax receipts nor government expenditures to grow.
	b.	real GDP growth is positive, which reduces both tax receipts and transfer payments.
	c.	real GDP growth is negative, which reduces transfer payments in relation to tax receipts.
	d.	real GDP growth is negative, which reduces tax receipts in relation to government expenditures.
	e.	real GDP growth is positive, which increases tax receipts in relation to government expenditures.

1. The primary tool used by supply-side economists to eliminate macroeconomic problems is

A. the discount rate.

B. corporate tax rates.

C. government spending.

D. open market operations.

E. the reserve requirement.

2. When the Federal Reserve System buys government securities on the open market,

A. the money supply will decrease.

B. excess reserves at commercial banks will decrease.

C. excess reserves at commercial banks will increase.

D. interest rates will increase

3. One of the advantages of automatic stabilizers over discretionary fiscal policy is that automatic stabilizers

A. has a greater multiplier effect than discretionary policy.

B. is not subject to the time lag problems of discretionary policy.

C. does not produce a deficit during recessions as a discretionary policy does.

D. makes the actual budget a better reflection of the condition of the economy than the full-employment budget.

4. "I have promised to do everything in my power to reduce the federal deficit. That means reducing federal expenditures and, if necessary, increasing taxes. Under present conditions of full employment and steady prices, we can afford to bear the burden of this debt (i.e., pay off the debt) now instead of passing it on to our children and grandchildren."

If the policies of the Senator quoted above were adopted, what effects would be expected while these policies were being implemented?

A. higher inflation

B. increases imports

C. higher rates of economic growth

D. increased unemployment and idle capacity

5. An inflationary gap can be reduced or completely closed by

A. decreasing taxes while leaving government spending on goods and services unchanged.

B. decreasing government spending on goods and services while leaving taxes unchanged.

C. increasing government spending on goods and services while leaving taxes unchanged.

D. increasing both government spending on goods and services and taxes by the same amount.

6. Compared to fiscal policy, an advantage of monetary policy is its

A. greater flexibility.

B. highly selective impact on segments of the economy.

C. ability to eliminate cost-push inflation.

D. need for approval by Congress.

E. need for approval by the President.

7. An increase in government spending on goods and services which causes a budget deficit to exist

A. is always inflationary.

B. is more inflationary than equal increases in private spending.

C. is usually not inflationary when the economy is operating at its full-employment level of output.

D. will not necessarily cause serious inflation as long as there are unemployed resources in the economy.

8. Some analysts believe the tax cuts enacted during the President H.W. Bush administration represented a supply-side economic policy rather than a Keynesian fiscal policy because

A. the tax cuts were accompanied by decreases in interest rates.

B. the tax cuts were accompanied by increases in government spending.

C. the tax cuts were primarily aimed at upper-income groups and businesses.

D. the tax cuts were primarily aimed at middle income and lower-income groups.

9. When the federal government is stabilizing the economy by increasing taxes, monetary authorities should

A. take actions to decrease interest rates.

B. increase the supply of money.

C. buy government securities in the open market.

D. follow an expansionary money policy.

E. follow a contractionary money policy.

10. Suppose a commercial bank has demand deposits (checking accounts) of $400,000, actual reserves of $170,000, and a reserve requirement of 20%. This single commercial bank can lend a maximum of ______ and the banking system can increase loans by a maximum of ______

A. $90,000 and $450,000.
B. $90,000 and $360,000.
C. $90,000 and $170,000.
D. $170,000 and $450,000.

E. both can lend an unlimited amount.

11. Which of the following would most likely result if the federal government increased its spending without changing tax revenues during a period of full employment?

A. inflation

B. a recession

C. lower interest rates

D. a larger net exports deficit

12. Fiscal policy that emphasizes cutting taxes as a means of improving incentives to work, and invest would be characterized in aggregate demand - aggregate supply framework primarily a shift

A. left in the aggregate demand curve.

B. left in the aggregate supply curve.

C. right in the aggregate supply curve.

D. no shift in either the aggregate demand curve or the aggregate supply curve.

13. Which of the following will result in the greatest increase in aggregate expenditures/demand?

A. A $100 decrease in personal income taxes

B. A $100 increase in personal income taxes

C. A $100 increase in government expenditures

D. A $100 increase in government expenditures which is accompanied by a $100 increase in personal income taxes

E. Both A and C will have the same effect on aggregate expenditures

14. You are given the following information about aggregate demand for an economy: (1)consumption = $600 billion; (2) investment = $50 billion; (3) government purchases = $100 billion; and (4) net export = $20 billion. If the full-employment level of GDP for this economy is $720 billion, then what combination of actions would be most consistent to achieve full employment and stable prices?

A. an increase in government spending and taxes

B. decrease government spending and taxes

C. decrease government spending and increase taxes

D. increase government spending and decrease taxes

15. Advocates of fiscal policy agree that discretionary fiscal policy will stabilize the business cycle most when the federal government

A. continuously incurs budget deficits.

B. continuously runs budget surpluses.

C. balances its budget every year.

D. incurs budget deficits during recessions and budget surpluses during demand-pull inflations.

E. incurs budget surpluses during recessions and budget deficits during demand-pull inflations.

16. Discretionary fiscal policy that increases the government budget deficit has the same effect on equilibrium as

A. an increase in personal saving.

B. an increase in business investment.

C. a decrease in government spending.

D. a decrease in personal consumption expenditures

pearseal757

Taxable Income Range	Marginal Tax Rate
$0 to $10,000	12%
$10,001 to $24,500	18%
$24,501 to $68,000	27%
$68,001 and above	38%

The table shows the taxable income range and marginal tax rates for a single taxpayer in Oceania. There are no exemptions or deductions on personal income taxes in Oceania.

1. Refer to Table 20.1. The income tax paid by George, a single taxpayer with an income of $65,000, is

A.$11,100.

B.$14,745.

C.$15,345.

D.$17,550.

2.The table shows the taxable income range and marginal tax rates for a single taxpayer in Oceania. There are no exemptions or deductions on personal income taxes in Oceania.

Refer to Table 20.1. George is a single taxpayer with an income of $65,000. What is George's average tax rate?

A.19.00%

B.22.68%

C.23.61%

D.27%

3.Of the following countries, in which one was the true marginal tax rate faced by the typical worker lowest and the average number of hours worked per week highest from 1993 through 1996?

A.Italy

B.Canada

C.the United States

D.Germany

4.Unlike with Social Security taxes, there is no threshold on earnings beyond which the Medicare tax collection stops.

False

True

5.Which of the following expenditures is classified as a discretionary expenditure of the U.S. federalâ government?
A.food stamps

B.Social Security

C.federal employee pensions

D.student loans and grants

6.For the U.S. federal government, mandatory spending refers to
A.spending that is not subject to Congress's annual appropriations process.

B.spending on federal employee salaries.

C.spending that never changes in amount from year to year.

D.spending that must be authorized by Congress each year.

7.Based on the current state of revenue of the Social Security and Medicare programs, the government has two options for funding, which are

A.cutting payroll taxes or raising benefits.

B.cutting payroll taxes or cutting benefits.

C.raising payroll taxes or cutting benefits.

D.raising payroll taxes or raising benefits.

8.Which of the following would be classified as fiscal policy?
A.The Environmental Protection Agency enacts stricter air pollution regulations.

B.The Federal Reserve cuts interest rates to stimulate the economy.

C.The federal government cuts taxes to stimulate the economy.

D.States increase taxes to fund education.

9.Automatic stabilizers refer to

A.the money supply and interest rates that automatically increase or decrease along with the business cycle.

B.changes in the money supply or interest rates that are intended to achieve economic stability.

C.changes in federal taxes and purchases that are intended to influence economic activity.

D.government spending and taxes that automatically increase or decrease along with the business cycle.

10.The implementation lag for fiscal policy ________ it is for monetary policy.

A.can be much longer than

B.is usually the same as

C.is generally much shorter than

D.There is not an implementation lag for fiscal policy.

11.When government decides to increase spending, interest rates generally ________ and this change in interest rates ________ investment spending.

A.decrease; increases

B.increase; decreases

C.decrease; decreases

D.increase; increases

12.The marginal propensity to consume is the proportion of each newâ dollar's worth of income that is spent.

True

False

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ECON 1BB3 Chapter Notes - Chapter 12: Purch Group, Deflation, Business Cycle

ECON 1BB3 Full Course Notes

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