When the economy is experiencing a recession automatic stabilizers will cause:
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transfer payments to increase and tax revenues to decrease.
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The graph to the right illustrates the static AD-AS model.
Suppose the economy is initially in long-run equilibrium at point A.
The government decides to decrease government spending.
In the short-run, this contractionary fiscal policy will cause:
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A shift from AD 2 to AD 1 and a movement to point D, with a lower price level and lower output.
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Suppose the economy is initially in long-run equilibrium. The government enacts a policy to increase government spending. In the short-run, this expansionary fiscal policy will cause:
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A shift from AD 1 to AD 2 and a movement to point B, with a higher price level and higher output.
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Change in GDP
Change in government spending
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= Multiplier x Change in Government Spending
= change in GDP / government purchases multiplier
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Suppose that real GDP is currently $13.33 trillion and potential real GDP is $14.0 trillion, or a gap of $700 billion. The government purchases multiplier is 5.0, and the tax multiplier is 4.0.
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Holding other factors constant, by how much will government purchases need to be increased to bring the economy to equilibrium at potential GDP?
Government spending will need to be increased by $
140billion. 700/5 = 140
Holding other factors constant, by how much will taxes have to be cut to bring the economy to equilibrium at potential GDP?
Taxes will need to be cut by $175 billion 700/4 = 175
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Suppose the government increases expenditures by $30 billion and the marginal propensity to consume is 0.90. By how will equilibrium GDP change?
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The change in equilibrium GDP is: $300.0 billion.
30 / .10 = 300
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Government purchases multiplier=
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Change in equilibrium real GDP/Change in government purchases.
If, for example, the government purchases multiplier has a value of 2, an increase in government purchases of $100 billion should increase equilibrium real GDP by 2×$100 billion=$200 billion.
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Multiplier effect
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The series of induced increases in consumption spending that results from an initial increase in autonomous expenditures.
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According to the multiplier effect , an initial increase in government purchases increases real GDP by _______
the initial increase in government purchases.
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more than
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Tax multiplier
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= Change in equilibrium real GDP /Change in taxes
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Suppose the government increases taxes by $10 billion and the marginal propensity to consume is 0.80. By how will equilibrium GDP change?
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The change in equilibrium GDP is: $−40.0 billion.
? .8 / .2 = 4 x 10 = 40
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Assume the tax multiplier is estimated to be 1.1 and the aggregate supply curve has its usual upward slope. Suppose the government lowers taxes by $58 million.
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Aggregate demand will
increase by $63.8 million
1.1 x 58 =63.8
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Why might increasing taxes as a fiscal policy be a more difficult policy than the use of monetary policy to slow down an economy experiencing inflation?
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The legislative process experiences longer delays than monetary policy.
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If the government increases expenditure without raising taxes, this will
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increase the budget deficit and require the government to borrow additional funds.
cause the interest rate to increase, thereby, reducing private investment and crowding out the private sector.
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The cyclically adjusted budget deficit is the deficit in the federal government's budget if:
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the economy were at potential GDP.
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A policy of decreasing the marginal income tax rate to increase labor supply is intended to result in:
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Long run supply side effects
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It is argued that a policy of tax simplification will result in:
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A shift from LRAS1 to LRAS2 with higher output at a lower price level.
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What is fiscal policy?
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Fiscal policy can be described as changes in government spending and taxes to achieve macroeconomic policy objectives
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Who is responsible for fiscal policy?
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The federal government controls fiscal policy.
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In 2009, Congress and the president enacted "cash for clunkers" legislation that paid people buying new cars up to $4,500 if they traded in an older, low gas-mileage car.
Was this piece of legislation an example of fiscal policy?
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Yes, because the primary goal of the spending program was to stimulate the national economy
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Some spending and taxes increase or decrease with the business cycle. This event often has an effect on the economy that is similar to fiscal policy and is called
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automatic stabilizers.
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