ECON1020 Lecture Notes - Lecture 9: Automatic Stabilizer, Aggregate Demand, Potential Output

48 views3 pages

periwinklecrab732

6 Jun 2018

School

Department

Economics

Course

ECON1020

Professor

Ian King

For unlimited access to Class Notes, a Class+ subscription is required.

Lecture 9 - Fiscal Policy

Thursday, 3 May 2018

2:00 PM

<<ECON 1020 Lecture 9.pdf>>

• Fiscal policy is changes in taxes, transfer payments and government purchases that are

specifically intended to achieve macroeconomic policy objectives

• These policies can have effects through aggregate demand in the short run and sometimes

aggregate supply in the long run

• Automatic stabilisers: Government transfers and taxes that automatically increase or

decrease along with the business cycle

• Discretionary fiscal policy: When the government takes deliberate action to change public

consumption, public investment, transfer payments or taxes to achieve its economic

objectives

Expansionary Fiscal Policy - GRAPH EXAMPLE ON SLIDES

• Involves increasing G or TR or decreasing T

• An increase in G will increase AD directly

• An increase in TR or a reduction in T has an indirect effect by increasing disposable income

and, thereby, consumption - which is a component in AD

• The goal of expansionary fiscal policy is to increase aggregate demand by more than it would

have increased without policy

• Appropriate in a recession i.e. economy at equilibrium but below full-employment

• Implementing expansionary fiscal policy at equilibrium

o In the short run, prices and output increase

o In the long run, prices are increased further but output returns to normal

o Therefore, it will cause inflation

• It can be used to offset a negative AD shock

• In the very long run

o In the very long run, LRAS continues to move to the right

o Therefore, SRAS will also be shifting to the right, AD shifts to the right also

o It is possible the AD will not increase enough so expansionary fiscal policy will have to be

used

Contractionary Fiscal Policy

• Involves decreasing G or TR or increasing T

• Appropriate when the economy is above full employment equilibrium and the inflation rate is

high

• The goal of contractionary fiscal policy is to decrease AD

• If contractionary fiscal policy is implemented at equilibrium

o In the short run, prices and output decrease

o In the long run, prices decrease further but output returns to normal

• It can be used to offset a positive AD shock

• In the very long run

o Sometimes AD can increase too fast and lead to inflation, causing an equilibrium above

potential GDP

o Contractionary fiscal policy is used to slow down the increase of AD during periods of

high or rising inflation

Government purchases and tax multipliers

• Multiplier effect: The process by which an increase in autonomous expenditure leads to a

larger increase in potential GDP

• Government purchase multiplier: An increase in government purchases will increase AD by

more than the initial amount of the increase in purchases

o = change in equilibrium real GDP / change in government purchases

find more resources at oneclass.com

Unlock document

This preview shows page 1 of the document.
Unlock all 3 pages and 3 million more documents.

Already have an account? Log in

Document Summary

Expansionary fiscal policy - graph example on slides. In the short run, prices and output increase. In the long run, prices are increased further but output returns to normal: therefore, it will cause inflation. It can be used to offset a negative ad shock. In the very long run, lras continues to move to the right: therefore, sras will also be shifting to the right, ad shifts to the right also. It is possible the ad will not increase enough so expansionary fiscal policy will have to be used. Involves decreasing g or tr or increasing t: appropriate when the economy is above full employment equilibrium and the inflation rate is high, the goal of contractionary fiscal policy is to decrease ad. If contractionary fiscal policy is implemented at equilibrium. In the short run, prices and output decrease. In the long run, prices decrease further but output returns to normal. It can be used to offset a positive ad shock.

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.

You hear on the nightly news that the president has vowed to decrease the nation's debt. Both the government and private citizens will have to buckle down and learn to do without, he says.

In order to reduce its debt, a nation must:

A.	run lower deficits.
B.	decrease tax rates.
C.	run lower surpluses.
D.	increase in government spending.

Debt reduction will result in:

A.	more public works projects, higher transfer payments, and more money available for households to spend.
B.	fewer public works projects, higher transfer payments, and more money available for households to spend.
C.	more public works projects, lower transfer payments, and less money available for households to spend.
D.	fewer public works projects, lower transfer payments, and less money available for households to spend.

A friend of yours looks at the state of the U.S. debt in 2011 and tells you, Since the debt is so high, we must be running an incredibly large deficit every year. Your friend's analysis is:

A.	not valid, because the debt is always changing even when deficits are the same.
B.	not valid, because the debt can be high even when the deficit for an individual year is small.
C.	valid, because the debt is always changing even when deficits are the same.
D.	valid, because the public debt is the sum of all deficits and surpluses run by the government over time and can be high even when the deficit for an individual year is small.

Assume that the government in some nations intended to respond to low employment via fiscal policy.

a. What type of policy would this require?

A.	A contractionary fiscal policy designed to decrease the aggregate demand curve.
B.	An expansionary fiscal policy designed to decrease the aggregate demand curve.
C.	An expansionary fiscal policy designed to increase the aggregate demand curve.
D.	A contractionary fiscal policy designed to increase the aggregate demand curve.

b. Assume that this policy ended up having an undesirable outcome. How could this happen in terms of formulation and implementation lags?

A.	This could happen if the implementation lag exceeded the formulation lag.
B.	This could happen if the formulation lag exceeded the implementation lag.
C.	This could happen if the formulation lag and the implementation lag exceeded the expansion.
D.	This could happen if the formulation lag and the implementation lag exceeded the recession.

Econo Nation started 2008 with no national budget debt or surplus. By the end of 2008, it had a budget surplus of $286 million; in 2009, it had a budget deficit of $-425 million; in 2010, it had a budget surplus of $100 million, and the amount of its budget deficit or surplus in 2011 is unknown. If at the end of 2011 Econo Nation's national debt totalled $52 million, determine the deficit or surplus in 2011.

Instructions: Enter your answer as a whole number and include a negative sign if there is a deficit.

Period	Deficit (-) or surplus (+)
Beginning of 2008	$0
End of 2008	$286 million
2009	$-425 million
2010	$100 million
End of 2011	_______ million

sapphiresalmon584

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

ECON1020 Lecture Notes - Lecture 9: Automatic Stabilizer, Aggregate Demand, Potential Output

Document Summary

Get access

Related Documents

ECON1020 Lecture 11: Fiscal Policy

ECON1020 Lecture Notes - Lecture 6: Stagflation, Monetarism, Rational Expectations

ECON1020 Study Guide - Final Guide: Real Business-Cycle Theory, Fiscal Policy, New Classical Macroeconomics

Related Questions