Chapter 11 example #36642

Aggregate demand. *From a Keynesian perspective, too little aggregate demand causes unemployment and too much aggregate demand causes inflation.

Fiscal policy. *Fiscal policy is the use of government taxes and spending to alter macroeconomic outcomes.

Income transfers. *Income transfers are payments to individuals for which no current goods or services are exchanged, such as Social Security, welfare, and unemployment benefits

An increase in taxes and a decrease in government spending *The fiscal policies available to the federal government for restraining aggregate demand are to reduce government spending, increase taxes, or decrease transfer payments.

Get consumers to spend more on goods and services. *From a Keynesian perspective, the way out of recession is to increase spending on goods and services.

Fiscal stimulus. *The fiscal policies available to the federal government for increasing aggregate demand are to increase government spending, decrease taxes, or increase transfer payments.

Increased government purchases *The fiscal policies available to the federal government for increasing aggregate demand are to increase government spending, decrease taxes, or increase transfer payments. Using interest rates to alter the macroeconomy is a monetary policy tool.

A recessionary GDP gap will still exist. *If aggregate demand increased by the amount of the recessionary GDP gap, the economy would fall short of full employment. Some of the increased demand pushes up prices instead of output. To reach full-employment equilibrium the AD curve must shift by the amount of the entire AD shortfall.

Marginal propensity to consume. *How much the aggregate spending changes for each government dollar spent depends on the value of the multiplier which is equal to 1 divided by 1 minus the marginal propensity to consume.

The total change in spending includes both the new government spending and the subsequent increases in consumer spending. *Fiscal stimulus such as increased government spending will set off the multiplier process. As a result of this, aggregate demand will increase (shift) in two distinct steps: (1) the initial fiscal stimulus and (2) induced changes in consumption.

Government spending decreased by $125 million. *The general formula for computing the desired stimulus (increase in government spending) is the AD shortfall divided by the multiplier, therefore $500 divided by 4 is equal to $125.

$1,000 billion. *The value of the multiplier is equal to 1 divided by 1 minus the marginal propensity to consume. If the MPC is .8, the multiplier is 5. The amount that AD increases from fiscal stimulus is equal to the multiplier times the new spending injection or fiscal stimulus. So if the government increases spending by $200 billion, the total change in spending will by $1000 billion (5 × 200).

$40 billion. *The desired fiscal stimulus is equal to the AD shortfall divided by the multiplier. ($120/4 = $30) The general formula for computing the desired tax cut is the desired fiscal stimulus divided by the MPC. ($30/.75 = $40) Therefore the government should decrease taxes by $40 billion.

Increase spending by $50 billion. *The general formula for computing the desired stimulus (increase in government spending) is the AD shortfall divided by the multiplier, therefore $200 billion divided by 4 (1/(1 - .75)) is equal to $50 billion. A decrease in spending or an increase in taxes would cause the shortfall to increase.

The multiplier process will contribute to an additional increase in aggregate demand which will cause an inflationary gap. *It is not necessary for the government to increase spending by the entire amount of the AD shortfall. Were government spending to increase by the amount of the shortfall, the AD curve would actually shift to an equilibrium level beyond full employment equilibrium. The economy would quickly move from a situation of inadequate aggregate demand to a situation of excessive aggregate demand.

Contains less fiscal stimulus than an increase in government spending of the same size. *Only part of a tax cut is used to increase consumption; the remainder is saved. Accordingly, the initial spending injection is less than the tax cut. This makes tax cuts less stimulating than government purchases of the same size. Multiple

Aggregate demand rises by the amount of the government spending *Changes in government spending are more powerful than changes in taxes or transfers. This implies that an increase in government spending seemingly "offset" with an equal rise in taxes will actually increase aggregate demand.

Increase by $100 billion. *The balanced budget multiplier is equal to 1. In this case, a $100 billion increase in government expenditures combined with an equivalent increase in taxes increases aggregate demand by $100 billion.

1 *Changes in government spending are more powerful than changes in taxes or transfers. This implies that an increase in government spending seemingly "offset" with an equal rise in taxes will actually increase aggregate demand. The balanced budget multiplier is equal to 1.

Reduce taxes *When the economy is in a slump, the government can stimulate the economy with more government purchases, tax cuts, or an increase in transfer payments.

It reduces the private sector's ability to raise the level of output *If the government raised taxes for this purpose, the fiscal stimulus would be largely offset by resultant declines in consumption and investment. If, instead, the government borrows the money from the private sector, less credit may be available to finance consumption and investment, again creating an offsetting reduction in private demand. In either case, government spending may "crowd out" some private expenditure. If this happens, some of the intended fiscal stimulus may be offset by the crowding out of private expenditure.

Consumption or investment as a result of an increase in government borrowing. *If the government raised taxes for this purpose, the fiscal stimulus would be largely offset by resultant declines in consumption and investment. If, instead, the government borrows the money from the private sector, less credit may be available to finance consumption and investment, again creating an offsetting reduction in private demand. In either case, government spending may "crowd out" some private expenditure. If this happens, some of the intended fiscal stimulus may be offset by the crowding out of private expenditure.

Move equilibrium to point Y because of an increase in the price level. *If aggregate demand increased by the amount of the recessionary GDP gap, we would get a shift from AD1 to AD2. The new equilibrium would occur at point Y, leaving the economy short of full employment (QF). Some of the increased demand pushes up prices instead of output.

Reduce, but not close, the GDP gap. *If aggregate demand increased by the amount of the recessionary GDP gap, we would get a shift from AD1 to AD2. The new equilibrium would occur at point Y which is still left of point Z, leaving the economy closer but still short of full employment (QF). Some of the increased demand pushes up prices instead of output.

True

Purchases to improve the education system

FALSE

$2,200,000,000

False

$250

Fiscal restraints.

$100

True

20.8