Chapter 13

Question 1

Define fiscal policy.

Answer 1

The discretionary changing of government expenditures or taxes to achieve national economic goals.

Question 2

What are some goals that fiscal policy aims to achieve?

Answer 2

High employment, price stability, and economic growth.

Question 3

What is the recessionary gap?

Answer 3

The amount by which the current level of real GDP falls short of the economy’s potential production if it were operating on the long-run aggregate supply curve.

Question 4

What is the definition of the inflationary gap?

Answer 4

The inflationary gap was defined as the amount by which the short-run equilibrium level of real GDP exceeds the long-run equilibrium level as given by the long-run aggregate supply curve.

Question 5

When the government decides to spend more (expansionary fiscal policy), the aggregate demand curve shifts to the ______.

Answer 5

Right.

Question 6

When the government decides to reduce spending, the aggregate demand curve typically shifts to the _____.

Answer 6

Left

Question 7

Holding all other things constant an increase in taxes will cause a ___ in aggregate demand, because ___________.

Answer 7

Decrease

It can reduce consumption, investment, net exports or a combination of all three.

Question 8

How will a decrease in taxes affect the short-run aggregate supply curve?

Answer 8

If taxes are decreased the short-run aggregate supply curve tends to shift to the right.

Question 9

If an increase in taxes is levied by the government, how will the short-run aggregate supply curve be affected?

Answer 9

The curve will tend to shift to the left.

Question 10

Under what circumstances would the government have an incentive to increase taxes in order to create positive fiscal policy changes?

Answer 10

If the equilibrium point between the short-run aggregate supply and the aggregate demand is to the right of the long-run aggregate supply a recessionary gap exists period. Levying additional taxes could help bring the aggregate demand curve to the left.

Question 11

Under what circumstance would the government have an incentive to decrease taxes?

Answer 11

When the equilibrium point between the aggregate demand and short-run aggregate supply is to the left of the long-run aggregate supply curve. Decreasing taxes can help shift the aggregate demand curve to the right

Question 12

True or False
An increase in government spending without raising taxes creates additional government borrowing from the private sector.

Answer 12

True

Question 13

True or False
when the government finances increased spending by additional borrowing it will push interest rates up. This will induce firms to cut back on planned investment spending.

Answer 13

True

Question 14

What is deficit spending?

Answer 14

A rise in government spending while holding taxes constant.

Question 15

What is the effect of deficit spending?

Answer 15

It tends to crowd out private spending, dampening the positive effect of increased government spending on aggregate demand.

Question 16

What is the crowding-out effect?

Answer 16

The tendency of expansionary fiscal policy to cause a decrease in planned investment or planned consumption in the private sector. It normally results due to the rise in interest rates.

Question 17

True or False

The crowding-out effect has no impact on the position of the aggregate demand curve.

Answer 17

False.
The crowding-out effect dilutes the effect of expansionary policy which causes the anticipated shift in the demand curve to be less than what was planned. In other words, you still have a recessionary gap.

Question 18

What is the Ricardian equivalence theorem?

Answer 18

The proposition that an increase in the government budget deficit has no effect on aggregate demand.

Question 19

A person’s consumption and savings decisions realistically depend on what two effects?

Answer 19

Current income and anticipated future income.

Question 20

What is the permanent income hypothesis?

Answer 20

A statement that proposes that an individual’s current flow of consumption depends on the individual’s permanent or anticipated lifetime income.

Question 21

According to the permanent income hypothesis, why does short-term stimulus-based economic activity rarely have any effect?

Answer 21

Because instead of spending the tax cut or rebate typically people saved most of the funds or use them to make payments on outstanding debts.

Question 22

What is a direct expenditure offset?

Answer 22

Actions on the part of the private sector in spending income that offset government fiscal policy actions.

Question 23

If there is a full direct expenditure offset the government spending multiplier is_____.

Answer 23

Zero

Question 24

What is the marginal tax rate?

Answer 24

The rate applied to the last or highest bracket of taxable income.

Question 25

The relationship between tax rates and tax revenues is sometimes called _____.

Answer 25

The Laffer curve.

Question 26

What is supply-side economics?

Answer 26

The theory that creating incentives for individuals and firms to increase productivity will cause the aggregate supply curve to shift outward.

Question 27

According to a supply-side economist, what is the effect of increasing the marginal tax rate?

Answer 27

Increases in marginal tax rates cause people to work less and decreases and marginal tax rates induce workers to work more.

Question 28

What is recognition time lag?

Answer 28

The time required to gather information about the current state of the economy.

Question 29

What is the action time lag?

Answer 29

The time between recognizing an economic problem and implementing policy to solve it.

Question 30

What is the effect time lag?

Answer 30

The time that elapses between the implementation of a policy and the results of that policy.

Question 31

What is the impact fiscal multiplier?

Answer 31

the actual intermediate multiplier effect of a fiscal policy action after taking into consideration direct fiscal offsets and another short-term crowding out of private spending.

Question 32

What is the cumulative fiscal multiplier?

Answer 32

The multiplier effect of a fiscal policy action applies to the long run. After all influences on equilibrium real GDP have it taken into account.

Question 33

What are some examples of “automatic stabilizers?”

Answer 33

1. The progressive tax system

2. Unemployment benefits