Chapter 10

Question 1

4 Classical position beliefs

Answer 1

• Say’s law holds, so that insufficient demand in the economy is unlikely
• Wages, prices and interest rates are flexible
• The economy is self-regulating
• Laissez-faire is the right and sensible economic policy

Question 2

Efficiency Wage Models

Answer 2

Models holding that it is sometimes in the best interest of business firms to pay their employees higher-than-equilibrium-wage rates.

Question 3

Assumptions for the simple Keynesian model

Answer 3

• The price level is assumed to be constant until the economy reaches its full employment or Natural Real GDP level
• No foreign sector. Model = closed economy.
• The monetary side of the economy is excluded.

Question 4

Keynes’ 3 basic points on consumption

Answer 4

• Consumption depends on disposable income (income minus taxes)
• Consumption and disposable income move in the same direction
• When disposable income changes, consumption changes by less

Question 5

Consumption Function

Answer 5

Relationship between consumption & disposable income.
Consumption is directly related to disposable income and is positive even at zero disposable income.
C = Co + (MPC)(Yd)

Question 6

Autonomous consumption (Co)

Answer 6

The part of consumption that is independent of disposable income.

Question 7

Marginal Propensity to Consume (MPC)

Answer 7

Ratio of the change in consumption to the change in disposable income: MPC = ∆C / ∆Yd

Question 8

3 Ways to increase C

Answer 8

• Raise autonomous consumption
• Raise disposable income
• Raise the MPC

Question 9

Saving

Answer 9

Difference between disposable income and consumption:
Saving = Disposable income - Consumption
S = Yd - [Co - (MPC)(Yd)]

Question 10

Marginal propensity to save

Answer 10

Ratio of the change in saving to the change in disposable income:
MPS = ∆S/∆Yd

Question 11

The MPC/MPS equality

Answer 11

MPC + MPS = 1

Question 12

Multiplier process

Answer 12

An initial rise in autonomous consumption leads to a rise in consumption for one person generating additional income for another person and leading to additional consumption spending by that person and so on….

Question 13

Multiplier

Answer 13

The number that is multiplied by the change in autonomous spending to obtain the overall change in total spending.
= 1/(1 - MPC)

If the economy operates below Natural Real GDP, then the multiplier is the number that is multiplied by the change in autonomous spending to obtain the change in Real GDP.

Question 14

5 Statements on the AD/AS and the Simple Keynesian Model

Answer 14

• Price level is constant until Natural Real GDP is reached
• AD curve shifts if there are changes in C, I or G
• The economy could be in equilibrium and in a recessionary gap too
• Private sector may not be able to get the economy out of a recessionary gap.
• Government may have a management role in the economy. (May have to raise aggregate demand)

Question 15

Progressive Income Tax

Answer 15

An income tax system in which one’s tax rate rises as taxable income rises

Question 16

Proportional Income tax

Answer 16

An income tax system in which a person’s tax rate is the same regardless of taxable income.

Question 17

Regressive Income Tax

Answer 17

An income tax system in which a person’s tax rate declines as his or her taxable income rises.

Question 18

Budget Deficit

Answer 18

Government expenditures greater than tax revenues

Question 19

Budget Surplus

Answer 19

Tax revenues greater than government expenditures

Question 20

Balanced Budget

Answer 20

Government expenditures equal to tax revenues

Question 21

Cyclical Deficit

Answer 21

The part of the budget deficit that is a result of a downturn in economic activity.

Question 22

Structural Deficit

Answer 22

The part of the budget deficit that would exist even if the economy were operating at full employment

Question 23

Public Debt

Answer 23

The total amount that the federal government owes its creditors.

Question 24

Value added

Answer 24

The difference between what a producer sells a good for and what is pays for an intermediate good.

Question 25

VAT

Answer 25

A tax applied to the value added at each stage of production.

Question 26

Fiscal Policy

Answer 26

Changes in government expenditures and/or taxes to achieve economic goals, such as low unemployment, stable prices and economic growth.

Question 27

Expansionary Fiscal Policy

Answer 27

Increases in government expenditures and/or decreases in taxes to achieve particular economic goals.

Question 28

Contractionary Fiscal policy

Answer 28

Deliberate changes of government expenditures and/or increases in taxes to achieve economic goals.

Question 29

Discretionary Fiscal Policy

Answer 29

Deliberate changes of government expenditures and/or taxes to achieve economic goals.

Question 30

Automatic Fiscal Policy

Answer 30

Changes in government expenditures and/or taxes that occur automatically without (additional) congressional action.

Question 31

Crowding Out

Answer 31

The decrease in private expenditures that occurs as a consequence of increased government spending or the financing needs of a budget deficit.

Question 32

Complete Crowding Out

Answer 32

A decrease in one or more components of private spending that completely offsets the increase in government spending.

Question 33

Incomplete Crowding Out

Answer 33

The decrease in one or more components of private spending that only partially offsets the increase in government spending.

Question 34

5 Types of lags and fiscal policy

Answer 34

- The data lag - Wait-and-see lag - Legislative lag - Transmission lag - Effectiveness lag

Question 35

The Data Lag

Answer 35

Policy makers are not aware of changes in the economy as soon as they happen

Question 36

Wait-and-see lag

Answer 36

After policy makers are aware of a downturn in economic activity, they rarely enact counteractive measures immediately. Instead they are cautious to ensure that the events are not just short-run phenomena.

Question 37

Legislative lag

Answer 37

After policy makers decide that some type of fiscal policy measure is required, Congress or the president has to propose the measure, build political support for it and get it passed.

Question 38

Transmission lag

Answer 38

Once enacted, a fiscal policy measure takes time to go into effect.

Question 39

Effectiveness lag

Answer 39

After being implemented, a policy measure takes time to affect the economy.

Question 40

3 Possible outcomes of the problem by the time a policy impact is felt

Answer 40

- Problem may no longer exist - May not exist to the degree it once did - May have changed

Question 41

Marginal (Income) Tax Rate

Answer 41

The change in a person's tax payment divided by the change in taxable income: ∆Tax payment / ∆Taxable income

Question 42

Laffer Curve

Answer 42

Shows the relationship between tax rates and tax revenues.

Question 43

Conclusion of Laffer Curve

Answer 43

As tax rates rise from zero, tax revenues rise, reach a maximum at some point and then fall with further increases in tax rates.

Question 44

3 Points on the Laffer curve

Answer 44

- Zero tax revenues will be collected at two tax rates: 0% and 100% - An increase in tax rates could cause tax revenues to increase - A decrease in tax rates could cause tax revenues to increase. (Yes, increase...)

Question 45

Tax Base

Answer 45

In terms of income taxes, the total amount of taxable income.

Question 46

2 Variables involved in tax revenues

Answer 46

- Tax base - Tax rate Tax revenue = Tax base * (average) Tax rate