ECON 325 Chapter Notes - Chapter 9: Government Budget Balance, Real Interest Rate, Indifference Curve

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maroonchimpanzee63

12 Feb 2014

School

University of Maryland

Department

Economics

Course

ECON 325

Professor

Sadik Arouba

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Document Summary

This chapter focuses on intertemporal decisions--that is, decisions that involve economic trade offs across periods of time. This chapter also examines the implications of intertemporal decision making for how government deficits affect macroeconomic activity. This model consists of many consumers, and a government that need not balance its budget and can issue debt to finance a government deficit. The ricardian equivalence theorem is an important of implication of this model. The theorem states that there are conditions under which the size of a government"s deficit is irrelevant to, in that it does not affect any macroeconomic variables of importance or the economic welfare of any individual. The consumption-savings decision is an intertemporal decision in the sense that it involves trade off between current and future consumption. Similarly, the government"s decision to finance its expenditures is an intertemporal decision in the sense that it involves trade off between future and current taxes.

Related Questions

41.Which of the following is a valid statement about the Keynesian and classical models of the macroeconomy?

A. Fiscal policy will affect output in the Keynesian model, but only the price level in the classical model.

B. The economy adapts quickly to demand shocks under the Keynesian model, but not under the classical model.

C. A sharp decrease in the value of a nation's currency will lead to higher price levels in the Keynesian model, but not in the classical model.

D. Increases in autonomous expenditure will increase aggregate demand in the Keynesian model, but not in the classical model.

E. An increase in the productive capacity of an economy will result in greater output in both the Keynesian and classical models.

42. Suppose the government spends $500M on a project that has absolutely no value to the country. Which statement about this project is correct?

A. If taxes were raised $500M to fund this project, the Keynesian model predicts that this will have no net effect on output in the economy.

B. If the government raised the money for this project by printing $500M in bonds and selling them to the Fed, the effect is exactly the same as if they sold the bonds to households.

C. The project will increase aggregate supply because it will increase the total quantity of goods and services supplied in the economy.

D. If the marginal propensity to save in the economy is equal to 0.25, the Keynesian model predicts that this project will result in a $2000M increase in GDP.

E. Under the assumptions of the classical model, the result of this project will be increased in both the price level and equilibrium GDP.

43. A particular economy has a consumption of $400M, a government deficit of $100M, taxes of $250M, and income of $800M. Which of the following statements must be true?

A. If the investment is zero, there is no foreign trade imbalance.

B. If the trade surplus is $50M, the investment will be equal to $100M.

C. If the capital account surplus is $50M, the investment will be equal to $100M.

D. If the trade surplus is $100M, there will be an investment.

E. None of the above statements is necessarily true.

44. Which piece of information would be least useful in trying to predict the effect of a $700M increase in government spending on equilibrium GDP?

A. marginal propensity to save

B. The slope of the aggregate supply curve

C. Whether taxes are raised to pay for the spending increase

D. The current level of structural unemployment

E. Whether the bonds used to finance the spending were sold to households or to the Fed

45.Which of the statements relating to full employment and full capacity is false?

A. At full employment there is no frictional unemployment; at full capacity, there is no structural unemployment.

B. The full-employment level of output is less than the full capacity level of output.

C. At full employment there is no cyclical unemployment; at full capacity, there is no frictional unemployment.

D. A government spending increase will result in increased output and price levels at full employment, but only increased price levels at full capacity.

E. In the long run, an economy that starts at full capacity will move to full employment.

46. What would be the effect of a law requiring that government spending equal tax revenues in each year?

A. Fiscal policy would be completely eliminated as a tool to control the macroeconomy.

B. Monetary policy would be completely eliminated as a tool to control the macroeconomy.

C. Fluctuations in GDP would become less severe.

D. The government spending multiplier would be effectively set to 1.0.

E. The marginal propensity to consume would be cut in half.

47.The total value of T-bonds, including T-notes and T-bills, in existence at any point in time, is:

A. The federal government spending deficit.

B. The trade deficit.

C. Less than government spending.

D. Necessarily less than GDP.

E. The national debt.

48. Which of the following would be a valid statement about a government plan to eliminate a trade deficit

A. A decrease in the trade deficit will decrease investment in the country.

B. An effective strategy would be to increase the money supply and increase the value of the national currency.

C. An effective strategy would be to increase interest rates and increase the value of the national currency.

D. This could be achieved through dramatically increasing aggregate supply.

E. The increase in net exports will result in a decrease in aggregate demand.

49. Crowding out has the effect(s) of:

A. Reducing the effectiveness of monetary policy if crowding out occurs in financial markets.

B. Decreasing the value of a nationâs currency if the crowding out occurs in financial markets.

C. Increasing the effectiveness of fiscal policy if the crowding out occurs in financial markets and increasing the effectiveness of monetary policy if the crowding out occurs in product markets.

D. Decreasing the effectiveness of fiscal policy if the crowding out occurs in financial markets and decreasing the effectiveness of both fiscal and monetary policy if the crowding out occurs in product markets.

E. Increasing the price of government bonds if the crowding out occurs in financial markets.

50. Which of the following will make crowding out in credit markets more severe?

A. A steep investment demand curve

B. A global credit market

C. Tax increases

D. A steep supply curve in the loanable funds market

E. None of the above

peachmacaw787

Target Statement for Assignment 8

When IT procurement managers do business across a transnational border (or choose which borders to negotiate across) it will be helpful for managers to be aware of what restraints or pressures exist on both sides of the border that will affect the negotiated price of the product or service being acquired. The understanding that Garrettâs entire pricing theory depends on the macroeconomic (and hence also political) environment emerges from considering relations between contract pricing and economic theory, specifically, the âreservation priceâ and âeconomic calculation problemâ.

A fixed-price strategy in Garrettâs account does not mean a price that is fixed legally; it means a price that is determined by negotiation between free parties, such as is described in Ch. 8, pp. 105-106. That is, in Garrettâs pricing theory there is a transaction pricing calculation performed on each side of the transaction. Contract pricing is a decision, about which what matters is not the type of contract but the locus of the decision, that is, who makes the decision, and under what constraints?

Garrettâs Chapter 8 answers: buyer and seller make the decision. In a free-market economy, the pricing decision would be entirely an outcome of their negotiation. In an interventionist economy, the decision is in part an outcome of the buyer-seller negotiation; however, the cost of such interventions as taxes, regulations, currency instability, or contract impairment by monetary inflation, and any price caps or floors are built into or reflected by the sellerâs offering price.

In free market economic planning where there is zero central economic planning, a first approximation to a contract price that is freely set by buyer and seller is the reservation price or âwalk-awayâ price for the buyer. The seller, too, has a âwalk-awayâ price. The negotiation can only occur, resulting in a contract, in the interval between the two. Buyer and seller make a decision through a negotiation based on the sellerâs estimate of the cost of performance and the buyerâs estimate of what price the market, established by other potential sellers, would bear -- both estimates being a function of history.

According to the economic calculation problem described by the economist Ludwig Von Mises, a freely agreed upon price that reflects the combination of the buyerâs and sellerâs needs or desires is based on a calculation of the type that cannot be performed in a condition of central economic planning by a government. Under central economic planning, or socialism, price determination is not a function of trading history, or of the sellers' willingness to sell or the buyers' willingness to buy at a given price, rather it is either an arbitrary or politically-influenced decision. Such central economic planning, Von Mises observes, replaces economic calculation â the statistical aggregate of all individual actions by buyers and sellers who freely set prices by their own transaction pricing calculations.

Under the free market modeled in the theory of Von Mises, contract pricing relies on the absence of such market intervention so that buyer and seller are totally free to set a price that allows a contract to occur in the interval between the seller's and buyer's respective walkaway prices. This decision of both parties to agree on a price in that interval is one component of economic calculation â a component that applies to a single trade or transaction and contributes to the statistical aggregate which, in turn, tends to govern resource allocation so as to bring supply and demand into alignment.

To a lesser extent, contract pricing described by Garrett in Chapter 8 relies largely on the absence of central economic planning. Why? Because when the state intervenes it either substitutes its decision for that of the buyer and seller, or at a minimum imposes price controls that either foster shortages or surpluses or else tend to preclude the contract from ever happening if the controlled price is below the sellerâs cost estimate.

Under contract pricing as described by Garrett, the parties to the contract are still able to perform calculations of reservation (walkaway) prices and determine whether they can do the deal at some price in the interval that does not cause either to walk away. However, in a market that is only partially free, interventions such as regulations, taxes, currency exchange fluctuations, or monetary inflation that increase the sellerâs cost do alter the pricing calculation and tend to narrow the interval within which the buyer and seller can come to agreement. That still-intact possibility of agreeing on a price sensitive to market conditions is the essence of the relationship between the economic theory of Von Mises and the contract pricing theory of Garrett.

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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.

ECON 325 Chapter Notes - Chapter 9: Government Budget Balance, Real Interest Rate, Indifference Curve

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