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Problem Set #9: Smartwork5: Chapter 16, Fiscal Policy: Homework
Terms in this set (20)
Although many countries have recently adopted expansionary fiscal policies with the hope of increasing their real GDP growth, these countries have pursued different fiscal policies. Below, match the country with the fiscal policy it is pursuing.
Infrastructure spending - Canada
Cut corporate taxes - France
More state spending - United States
Spending on Refugees - Germany
As an elected official, you have been informed that real GDP is below its potential and that action should be taken to encourage economic growth and bring the economy to its long-run equilibrium. The marginal propensity to consume is 0.7, and the amount of new government spending is $600 billion.
What is the multiplier? Compute this to the first place beyond the decimal.
By how much would the economy be stimulated?
With a marginal propensity to consume of 0.7, the multiplier is 3.3. An increase in government spending of $600 billion multiplied by 3.3 results in a $1,980 billion increase in real GDP.
The graph below shows initial equilibrium in the loanable funds market at $800 million and an interest rate of 4%, point A. Now assume that the government increases spending by $100 million that is entirely deficit-financed. The new equilibrium in the loanable funds market is now $840 million and an interest rate of 5%, point B.
$840; $740; $100; $40
During the fall of 2007, the United States economy began a descent into deep recession. As a result, the federal government and the Federal Reserve took action to stimulate economic growth. Which of the following would have been an appropriate fiscal policy?
-the federal government spending more money to build more infrastructure
-the federal government providing tax refunds to many taxpayers
Explanation: Fiscal policy involves the use of spending or taxation by the federal government. During the Great Recession, the federal government provided tax refunds to many taxpayers and increased spending to build infrastructure. Both actions are forms of fiscal policy.
Assume the economy is operating beyond the full-employment output level, as shown in the graph below. The government wants to use contractionary fiscal policy to correct the situation. Drag the appropriate line to the correct position to show the change.
Drag AD2 downward to the intersection between LRAS1 & SRAS1
The American Recovery and Reinvestment Act introduced a large amount of government spending into the economy—$789 billion! Suppose the marginal propensity to consume in the United States is 0.85. How much would the program increase total spending in the economy?
_______ billion (NOTE: You may round to the nearest dollar.)
a: $3156.00 billion
Explanation: A marginal propensity to consume of 0.75 gives a multiplier of 6.66
$789 billion × 6.66 = $5254.73 billion.
The government of a country has decided to lower income taxes in an attempt to expand the economy to the full-employment output level. Assume the policy is successful. Shift the appropriate curve to the correct position.
Consider the Economic Stimulus Act passed in 2008. Which of the following could have caused real GDP to remain negative through the first half of 2009?
Explanation:The Economic Stimulus Act was passed in February 2008, but it took 6 months before citizens received tax rebates. The result was an implementation lag. When citizens finally received checks, it took time for them to spend their money and for the policy to reach its full effect—an impact lag.Because the economic downturn had already been recognized, a recognition lag would not have contributed to real GDP remaining negative through the first half of 2009.
Which of the following policies represents an automatic stabilizer with respect to fiscal policy?
As corporation report lower profits, their tax bill falls
When income levels fall during an economic recession, the government spends more money for poverty-reduction programs, such as food stamps.
An automatic stabilizer is a fiscal policy that reduces or encourages the rate of economic growth as appropriate. When the economy falls into a recession, government spending automatically increases as more people use antipoverty programs, such as food stamps.
If the government gave tax breaks for education, what type of fiscal policy would that be?
Based on your answer to Part 1 above, drag the appropriate curve in the graph below to show the effect of the education tax credits.
supply-side fiscal policy
shift LRAS to the right
In the graph below, AD1 shows where the economy was operating before fiscal policy was implemented, and AD2 shows the effects of a successful fiscal policy with no crowding out. On the graph, drag AD2 to its correct position if the fiscal policy led to complete crowding out.
drag AD2 to match AD1
When the economy is in a recession, the government can use expansionary fiscal policy to stimulate and encourage economic growth. Which of the following scenarios represent expansionary fiscal policies from both a supply perspective and a demand perspective?
-The government lowers tax rates and issues a partial refund of taxes that have already been paid
-The government lowers tax rates and undertakes a replacement of old bridges and roads
Explanation: From a supply-side perspective, the government can lower tax rates. Doing so gives people the incentive to work harder and earn more income. In the process, more output is produced, thus shifting the short- and long-run aggregate supply curve to the right. From a demand-side perspective, either partially refunding previously paid taxes or undertaking an infrastructure project (increasing government spending) should increase aggregate demand. Both represent expansionary fiscal policies.
During the Great Recession, the U.S. budget deficit worsened as tax collections fell and payments to the poor rose. In other words, the deficit worsened as a result of _________ in the federal budget.
Explanation: Automatic stabilizers are government programs that automatically implement countercyclical fiscal policies in response to economic conditions. So, when the economy is going through a recession, the amount collected in tax revenue from income taxes falls as incomes fall. In addition, as more people apply for government aid in the form of welfare or unemployment benefits, government spending increases. The decrease in revenue and increase in spending mean that the government has a larger budget deficit than before.
The graph below shows the situation in a loanable funds market where, presently, the entire supply of loanable funds comes from private savings activity, and the entire demand comes from private borrowing. The market quantity (money lent to borrowers) stands at $300 billion, and the interest rate stands at 3%.
Shift the demand curve to model the effect of a move by the government to borrow $150 billion, which it will spend on infrastructure in order to boost capital resources and at the same time create jobs in the construction industry.
Because of the crowding-out effect, the total market quantity of funds lent to borrowers did not increase by $150 billion. Rather, it increased by only ______ billion.
move D2 to (400, 3.5)
What are the consequences of automatic stabilizers when real GDP increases?
Tax revenues increase and payments to individuals decrease
Explanation: When real GDP increases, people have more taxable income. In addition, government payments to individuals will decrease as fewer people are eligible for unemployment benefits or income aid to the poor
Suppose the economy is in a recession. The economy needs to expand by at least $350 billion, and the marginal propensity to consume is 0.7.
What is the least amount the government can spend to overcome the $350 billion gap?
Knowing that the marginal propensity to consume is 0.7, we should first find the spending multiplier (m^s), defined by the following equationm^s= 1/(1-mpc)Solving for the spending multiplier gives us: 3.33
We are told that a $350 billion gap needs to be closed. Given the spending multiplier, the government needs to spend only the dollars that would multiply to
$350 billion ÷ 3.33 = $150.11 billion.
In a bid to be re-elected president of the United States, you promise both a lower tax rate and greater tax revenue. Would you be able to back up this promise with economic reasoning? Use the Laffer curve, shown here, to support your answer.
Yes, but only if the current tax rate is in region II of the Laffer curve.
Suppose that the president of a small island nation has decided to increase government spending by outfitting an expedition to explore the intricate system of underwater caves around the island. The legislation was enacted without any delay. From here, planning will take 6 months and initial scouting will take 2 months.
The planning and initial scouting of the explorers represent an impact lag of this policy.
Suppose that, during a recession, the government borrows money to provide low-cost prescription medicines to poor families. Which of the following statements are correct?
-The low-cost prescription medicines to poor families will likely raise interest rates as the government borrows more money to finance the purchase.
-Crowding-out will occur as individuals choose to rely on free medications instead of purchasing their own.
-This policy will likely be accompanied by an impact lag as the policy takes time to make its way to the people.
The multiplier effect of fiscal policy predicts that an increase in government spending of $250 billion will increase total income by $1000.00 billion if the marginal propensity to consume is 0.75. If we account for crowding-out, then the increase in aggregate demand will be
less than $1000.00 billion.
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