ECON1102 Chapter Notes - Chapter 13: Aggregate Demand, Unemployment Benefits, Deflation

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17 May 2018

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Chapter 13: Fiscal Policy

Fiscal Policy: Changes in federal taxes and purchases that are intended to achieve

macroeconomic policy objectives, such as high employment, price stability and

healthy rates of economic growth

• Only refer to actions of federal government

Automatic Stabilisers: Transfer payments and taxes that automatically increase or

decrease along with the business cycle

• Expenditure policies: unemployment compensation, welfare payments

• When economy contracts these components automatically rise →

countercyclical

Discretionary Fiscal Policy: When the government is taking actions to change

spending or taxes to achieve its economic objectives (fiscal policy)

• Government makes explicit choices and takes direct actions to change

spending/taxes to achieve economic objectives

Using Fiscal Policy to Influence Aggregate Demand

Expansionary Fiscal Policy: Increases in government purchases or decreases in

taxes in order to increase aggregate demand

• Shift AD curve further to the right than it would have without policy

• Increase in government purchases → increase aggregate demand directly

• Reduction in taxes → indirect effect on aggregate demand through the effect

on disposable income

• Appropriate when the economy is in equilibrium, below full-employment

(during contraction or recession)

Contractionary Fiscal Policy: Decreases in government purchases or increases in

taxes in order to reduce the increases in aggregate demand

• Decrease in government purchases/increase in taxes will reduce rate of

increase in AD to reduce inflation rate

• Policy appropriate when the economy is above full-employment equilibrium

and the inflation rate is high

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Overall:

Problem

Type of Policy

Actions by the

Government

Results

Economic

contraction or

recession

Expansionary

Increase

government

spending or cut

taxes

Real GDP and the

price level rise by

more than they

would have without

policy

Rising inflation rate

Contractionary

Decrease

government

spending or raise

taxes

Real GDP and the

price level do not

rise by as much as

they would have

without policy

Budget Deficits/surplus:

• Not necessarily ‘stimulative’

• Federal government budget deficits increase automatically during economic

contractions and recessions because of automatic stabilisers i.e.

1. Tax revenues fall

2. Unemployment benefit payments increase

• Must consider the cyclically adjusted budget deficit/surplus (deficit/surplus if

economy were at potential GDP

Multiplier Effect: The process by which an increase in autonomous expenditure leads

to a larger increase in real GDP

• With discretionary fiscal policy → change in G acts as an increase in

autonomous expenditure – impact is multiplied throughout economy

• Works also in reverse → fall in G

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Document Summary

Fiscal policy: changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives, such as high employment, price stability and healthy rates of economic growth: only refer to actions of federal government. Automatic stabilisers: transfer payments and taxes that automatically increase or decrease along with the business cycle: expenditure policies: unemployment compensation, welfare payments, when economy contracts these components automatically rise countercyclical. Discretionary fiscal policy: when the government is taking actions to change spending or taxes to achieve its economic objectives (fiscal policy: government makes explicit choices and takes direct actions to change spending/taxes to achieve economic objectives. Increase in government purchases increase aggregate demand directly on disposable income: appropriate when the economy is in equilibrium, below full-employment (during contraction or recession) Real gdp and the price level rise by more than they would have without policy. Real gdp and the price level do not rise by as much as they would have without policy.

Related Questions

In an effort to move the economy out of a recession, the federal government would engage in expansionary economic policies. Respond to the following points in your paper on the actions the government would take to address expansionary fiscal and monetary policies:

Expansionary Fiscal Policy:

Explain the actions the federal government would take while engaging in expansionary fiscal policy in terms of the following:

The necessary change in taxes and government spending,

The effect on aggregate demand, GDP, and employment.

Expansionary Monetary Policy:

The three tools the Federal Reserve Bank (The Fed) uses when conducting monetary policy are the required reserve ratio, the discount rate, and open market operations.

Explain the actions of the Fed in regard to the three tools.

When the required reserve ratio is increased or decreased

When the discount rate is increased or decreased

Buying or selling government securities when conducting expansionary monetary policy

Explain how these actions would affect the money supply, interest rates, spending, aggregate demand, GDP, and employment.

raspberrygoose799

5. Fiscal policy is enacted through changes in

A. interest rates and the price level.

B. the supply of money and foreign exchange.

C. unemployment and inflation

D. taxation and government spending.

6. In an economy, the government wants to decrease aggregate demand by $48 billion at each price level to decrease real GDP and control demand-pull inflation. If the MPS is 0.25, then it could

A. increase taxes by $16 billion.

B. increase taxes by $24 billion.

C. decrease government spending by $10 billion.

D. decrease government spending by $16 billion.

7. If there is a constitutional requirement to maintain a balanced budget, then during a recession when tax revenues are shrinking, the government will have to implement

A. contractionary fiscal policy.

B. no change in fiscal policy.

C. expansionary fiscal policy.

D. countercyclical fiscal policy.

8. Most economists believe that fiscal policy is:

A. better than the monetary policy for "fine-tuning" the economy.

B. better than the monetary policy for month-to-month stabilization.

C. not as good as the monetary policy for month-to-month stabilization.

D. not very good at pushing the economy in a particular direction.

9. An increase in the legal reserve ratio

A. increases the money supply by increasing excess reserves

B. decreases the money supply by decreasing excess reserves

C. increases the money supply by decreasing excess reserves

D. decreases the money supply by increasing excess reserves

10. The discount rate is the rate of interest at which

A. Federal Reserve Banks lend to commercial banks

B. savings and loan associations lend to some builders

C. Federal Reserve Banks lend to large corporations.

D. commercial banks lend to large corporations

11. Which of the following actions by the Fed most likely increase commercial bank lending?

A. raising the reserve ratio

B. increasing the federal funds rate target

C. reducing the interest paid on excess reserves held at the Fed

D. selling bonds to commercial banks and the public

12. Assume the economy is operating at less than full employment. An expansionary monetary policy will cause interest rates to ______, which will ______ investment spending.

A. decrease; decrease

B. decrease; increase

C. increase; increase

D. increase; decrease

sapphirecrow883

Taxable Income Range	Marginal Tax Rate
$0 to $10,000	12%
$10,001 to $24,500	18%
$24,501 to $68,000	27%
$68,001 and above	38%

The table shows the taxable income range and marginal tax rates for a single taxpayer in Oceania. There are no exemptions or deductions on personal income taxes in Oceania.

1. Refer to Table 20.1. The income tax paid by George, a single taxpayer with an income of $65,000, is

A.$11,100.

B.$14,745.

C.$15,345.

D.$17,550.

2.The table shows the taxable income range and marginal tax rates for a single taxpayer in Oceania. There are no exemptions or deductions on personal income taxes in Oceania.

Refer to Table 20.1. George is a single taxpayer with an income of $65,000. What is George's average tax rate?

A.19.00%

B.22.68%

C.23.61%

D.27%

3.Of the following countries, in which one was the true marginal tax rate faced by the typical worker lowest and the average number of hours worked per week highest from 1993 through 1996?

A.Italy

B.Canada

C.the United States

D.Germany

4.Unlike with Social Security taxes, there is no threshold on earnings beyond which the Medicare tax collection stops.

False

True

5.Which of the following expenditures is classified as a discretionary expenditure of the U.S. federalâ government?
A.food stamps

B.Social Security

C.federal employee pensions

D.student loans and grants

6.For the U.S. federal government, mandatory spending refers to
A.spending that is not subject to Congress's annual appropriations process.

B.spending on federal employee salaries.

C.spending that never changes in amount from year to year.

D.spending that must be authorized by Congress each year.

7.Based on the current state of revenue of the Social Security and Medicare programs, the government has two options for funding, which are

A.cutting payroll taxes or raising benefits.

B.cutting payroll taxes or cutting benefits.

C.raising payroll taxes or cutting benefits.

D.raising payroll taxes or raising benefits.

8.Which of the following would be classified as fiscal policy?
A.The Environmental Protection Agency enacts stricter air pollution regulations.

B.The Federal Reserve cuts interest rates to stimulate the economy.

C.The federal government cuts taxes to stimulate the economy.

D.States increase taxes to fund education.

9.Automatic stabilizers refer to

A.the money supply and interest rates that automatically increase or decrease along with the business cycle.

B.changes in the money supply or interest rates that are intended to achieve economic stability.

C.changes in federal taxes and purchases that are intended to influence economic activity.

D.government spending and taxes that automatically increase or decrease along with the business cycle.

10.The implementation lag for fiscal policy ________ it is for monetary policy.

A.can be much longer than

B.is usually the same as

C.is generally much shorter than

D.There is not an implementation lag for fiscal policy.

11.When government decides to increase spending, interest rates generally ________ and this change in interest rates ________ investment spending.

A.decrease; increases

B.increase; decreases

C.decrease; decreases

D.increase; increases

12.The marginal propensity to consume is the proportion of each newâ dollar's worth of income that is spent.

True

False

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ECON1102 Chapter Notes - Chapter 13: Aggregate Demand, Unemployment Benefits, Deflation

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