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Principles of Macroeconomics
Terms in this set (10)
During a recession, the government spends $100 million to stimulate the economy. If the marginal propensity to consume is 0.8, what will be the potential increase in income in the economy as a result of the government's increase in the spending level?
FEEDBACK: The multiplier process suggests that an increase in government spending by $100 million will potentially create more than $100 million in income. The spending multiplier is given by 1 ÷ (1 - MPC) = 1 ÷ (1 - 0.8) = 1 ÷ 0.2 = 5. Thus, the income level will increase 5 times the initial change in government spending. So, the total increase in income will be 5 × $100 million = $500 million.
The main goal of supply-side fiscal policy is
Shift long-run aggregate supply (LRAS)
FEEDBACK: Supply-side fiscal policy involves the use of government spending and taxes to shift long-run aggregate supply (LRAS), which moves the economy from one full-employment output level to a new full-employment output level.
Suppose the U.S. economy was operating at t * on the Laffer Curve in 2016. Tax revenues would __________ in 2017 as a result of the Tax Cuts and Jobs Act of 2017.
FEEDBACK: The Trump tax cuts of 2017 lowered marginal tax rates. If the U.S. economy was at t * on the Laffer Curve in 2016, then a lowering of tax rates would decrease total tax revenue.
Consider equilibrium in the loanable funds market with savings and investment equal to $150 million. The government increases its spending by $100 million and finances the deficit entirely through borrowing in the loanable funds market. If the equilibrium quantity of loanable funds increases to $170 million, assuming complete crowding out, consumption must fall by __________, and the new level of investment must be __________.
$20 million; $70 million
FEEDBACK: Owing to an increase in government spending, the equilibrium level of loanable funds increases from $150 million to $170 million. Thus ($170 - $150) = $20 million goes to the government to finance part of the $100-million increase in spending. This $20 million comes from increased savings, which must cause consumption to fall by $20 million. The other $80 million borrowed causes private investment to decline by $80 million. Hence, the new level of private investment is ($150 - $80) = $70 million.
The multiplier effect of fiscal policy predicts that an increase in government spending by $100 billion will increase total income by $400 billion if the marginal propensity to consume is 0.75. If we account for PARTIAL crowding out, then the increase in income will be
Less than $400 billion
FEEDBACK: An increase in government spending has the effect of shifting the aggregate demand curve to the right. Crowding out has the opposite effect of reducing private spending and aggregate demand. Hence, the full impact of the increase in government spending on aggregate demand will not be realized in the presence of crowding out, and the total increase in income will be less than $400 billion.
If an economy is experiencing an unemployment rate less than the natural rate, which of the fiscal policies would you suggest in order to restore the economy to full employment?
FEEDBACK: When the economy is expanding beyond its long-run capabilities, the economy is producing at levels higher than full-employment GDP, and the unemployment rate is lower than the natural rate of unemployment. The correct policy prescription here would be to reduce aggregate demand, which can be achieved by contractionary fiscal policy--either increasing taxes or lowering government spending.
For relatively low tax rates, an increase in tax rates will have what effect on tax revenue?
Increase tax revenue
FEEDBACK: Total income tax revenue depends on the level of income and the tax rate. For relatively low tax rates, an increase in tax rates has a greater marginal effect on overall tax revenue than on post-tax income as an incentive for workers to keep working. Therefore, increasing the tax rate in this region will lead to higher tax revenue.
Which of the following lags associated with fiscal policy is expected to be alleviated by automatic stabilizers such as unemployment benefits?
FEEDBACK: The policy prescription to address business cycles is to increase spending and cut taxes during a downturn and to lower spending and raise taxes during an expansion. But in the real world, it is difficult to recognize when expansion or contraction starts, and the appropriate fiscal policy intervention might get delayed. Similarly, since government spending and tax legislation need to be appropriated to law before implementation, such implementation is likely to get delayed by months after the advent of expansions or contractions. However, automatic stabilizers like unemployment benefits will automatically increase during downturns when the number of unemployed people rises, and will decrease during expansions with lower unemployment rates. Thus, automatic stabilizers are expected to alleviate both recognition and implementation lags associated with fiscal policies.
Which of the following would cause crowding out during the Great Recession of 2007-2009?
The American Recovery and Reinvestment Act
FEEDBACK: The American Recovery and Reinvestment Act of 2009 focused on increased government spending, which increased the demand for loanable funds and caused crowding out. The Bush tax cuts and the Economic Stimulus Act of 2008 focused on tax cuts and tax rebates and did not affect the demand for loanable funds.
According to the new classical critique of fiscal policy, an increase in government spending today will lead to what change in current savings?
FEEDBACK: The new classical critique of fiscal policy asserts that increases in government spending today will eventually be financed by higher future taxes. Hence, people will anticipate having to pay higher taxes eventually and will therefore increase their current savings.
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