Chapter 7 Flashcards
(18 cards)
A reduction in the net tax rate changes equilibrium income by __________ the AE curve, resulting in a(n) __________ slope.
a) rotating; flatter
b)rotating; steeper
c) shifting; flatter
d) shifting; steeper
b) rotating; steeper
- A reduction in the net tax rate changes equilibrium income by rotating the AE curve. The new curve has a steeper slope because the lower net tax rate withdraws a smaller amount of national income from the desired consumption flow. Equilibrium income rises. An increase in the net tax rate has the opposite effect.
The simple multiplier is raised when the marginal propensity to import is:
a) either raised or lowered, depending on the case
b) left unchanged
c) lowered
d) raised
c) lowered
- The simple multiplier with government and foreign trade = 1 / (1 – [MPC(1 – t) – m]).
From the above equation, when m (the marginal propensity to import) decreases, the simple multiplier increases.
The lower the marginal propensity to import, the higher the simple multiplier.
AE = C + I + G + (X – IM)
C = c + (MPC)(YD) = c + MPC(1 – t)Y = consumption
I = investment
G = government purchases
T = tY = net tax revenues
X = exports
IM = mY = imports
Then, induced expenditure equals:
a) m + I + G + X
b) [MPC(1 – t) – G]Y
c) c + I + G + X
d) [MPC(1 – t) – m]Y
d) [MPC(1 – t) – m]Y
AE = C + I + G + (X – IM)
AE = c + MPC(1 – t)Y + I + G + (X – mY)
AE = [c + I + G + X] + [MPC(1 – t) – m]Y
Autonomous expenditure: c + I + G + X
Induced expenditure: [MPC(1 – t) – m]Y
AE = C + I + G + (X – IM)
C = c + (MPC)(YD) = c + MPC(1 – t)Y = 45 + 0.9(1 – 0.10)Y = consumption
I = 70 = investment
G = 50 = government purchases
T = tY = 0.2Y = net tax revenues
X = 55 = exports
IM = mY = 0.1Y= imports
Given the above information, the marginal propensity to spend out of national income equals:
the marginal propensity to spend out of national income = MPC(1 – t) – m = 0.71.
MPC(1 – t) – m = (0.9)(0.9) – 0.1 = 0.71
The simple multiplier is __________ when government and foreign trade are included, and the AE curve is __________.
a) smaller; flatter
b) smaller; steeper
c) larger; steeper
d) larger; flatter
a) smaller; flatter
a) When we introduce government and foreign trade to our model, the simple multiplier becomes smaller. Since some of any increase in national income goes to taxes and imports, the induced increase in desired expenditure on domestically produced goods is reduced. The resulting AE curve is flatter. Also, in response to any change in autonomous expenditure, the overall change in equilibrium GDP is smaller.
AE = C + I + G + (X – IM)
C = c + (MPC)(YD) = c + MPC(1 – t)Y = consumption
I = investment
G = government purchases
T = tY = net tax revenues
X = exports
IM = mY = imports
Then, autonomous expenditure equals:
= c + I + G + X
AE = C + I + G + (X – IM)
AE = c + MPC(1 – t)Y + I + G + (X – mY)
AE = [c + I + G + X] + [MPC(1 – t) – m]Y
Autonomous expenditure: c + I + G + X
Induced expenditure: [MPC(1 – t) – m]Y
Net exports (NX) are:
a) an autonomous expenditure only
b) an induced expenditure only
c) negatively related to national income
d) positively related to national income
c) negatively related to national income
- Exports (X) depend on spending decisions made by foreign households and firms.
Imports (IM) depend on spending decisions made by domestic households and firms.
(IM = mY, where m is the marginal propensity to import and Y is national income.)
NX = X – IM
NX = X – mY
Since exports are autonomous with respect to Y, but imports are positively related to Y, net exports are negatively related to national income. This negative relationship is called the net export function.
Stabilization policy is used to __________ the economy’s cyclical fluctuations and thereby stabilize national income.
a) increase
b) disguise
c) reduce
d) distort
c) reduce
- Deviations of actual GDP (Y) from potential GDP (Y) usually create problems. When Y < Y, factor incomes are low and unemployment of factors is high; when Y > Y, rising costs create inflationary pressures. To reduce these problems, governments often try to stabilize the level of real GDP close to Y. Any attempt to use government policy in this manner is called stabilization policy.
An increase in government purchases:
a) shifts the AE curve downward and tends to lower equilibrium national income
b) shifts the AE curve downward and tends to raise equilibrium national income
c) shifts the AE curve upward and tends to raise equilibrium national income
d) shifts the AE curve upward and tends to lower equilibrium national income
c) shifts the AE curve upward and tends to raise equilibrium national income
- One of the fiscal policy tools available to government policymakers is government purchases (G). An increase in government purchases shifts the AE curve upward, setting in motion the multiplier process that tends to increase equilibrium national income. A decrease in government purchases shifts the AE curve downward and tends to decrease equilibrium national income.
The simple multiplier is lowered when the net tax rate is:
a) raised
b) left unchanged
c) lowered
d) either raised or lowered, depending on the case
a) raised
The simple multiplier is lowered when the net tax rate is raised.
The simple multiplier with government and foreign trade = 1 / (1 – [MPC(1 – t) – m]).
From the above equation, when t (the net tax rate) increases, the simple multiplier decreases.
The higher the net tax rate, the lower the simple multiplier.
A depreciation of the Canadian dollar causes the net export (NX) function to:
a) shift downward and become steeper
b) shift upward and become steeper
c) shift upward and become flatter
d) shift downward and become flatter
c) shift upward and become flatter
- A depreciation of the Canadian dollar means that foreigners must pay less of their money to buy one Canadian dollar and that Canadian residents must pay more Canadian dollars to buy a unit of any foreign currency. As a result, the price of foreign goods in terms of Canadian dollars rises and the price of Canadian goods in terms of foreign currency falls. This reduction in the relative price of Canadian goods will cause a shift in expenditure away from foreign goods and toward Canadian goods. Canadian residents will import less at each level of Canadian national income, and foreigners will buy more Canadian exports. The net export (NX) function thus shifts upward and becomes flatter.
An increase in domestic prices relative to foreign prices will cause the marginal propensity to import (m) to __________ and the IM curve to __________.
a) fall; rotate down
b) rise; rotate down
c) rise; rotate up
d) fall; rotate up
c) rise; rotate up
An increase in Canadian prices relative to foreign prices will result in:
Foreigners seeing Canadian goods as more expensive relative both to goods produced in their own country and to goods imported from countries other than Canada.
Canadians seeing imports from foreign countries as less expensive relative to Canadian-made goods.
Canadians and foreigners will shift their expenditures toward foreign goods and away from Canadian goods.
The value of Canadian exports will fall and the X curve shifts down. The marginal propensity to import (m) will rise and the IM curve will rotate up. The combination of these two effects is that the net export function shifts downward and becomes steeper.
A fall in Canadian prices relative to foreign prices would have the opposite effect, shifting the X function up and the IM function down, and thus rotating the NX function up.
When incomes rise faster in Canada than in other countries:
a) canadian net exports will fall
b) canadian net exports will rise
c) consumption will rise slower than imports
d) consumption will rise faster than imports
a) canadian net exports will fall
- Net exports is computed as exports minus imports. When Canadian incomes increase faster than other countries, Canada will import more foreign products and do so at a faster rate than Canadian exports increase. The net impact will be a decline in Canadian net exports.
What is the size of Canada’s multiplier if we assume the following:
In Canada the value of t is 0.23, the approximate share of combined government net taxation in GDP.
Imports into Canada are close to 36 percent of GDP, and so m = 0.36 is a reasonable value.
The marginal propensity to consume out of disposable income is 0.75
d) 1.28
From these assumptions, the implied value of z is
z = MPC(1 - t) - m
= 0.75(1 - 0.23) - 0.36 = 0.2175
and so the implied value of the simple multiplier is:
Simple multiplier = 1/(1 - 0.2175) = 1/0.7825 = 1.28
Two main lessons emerge from this analysis:
1. Net taxes and imports reduce the size of the simple multiplier.
2. Realistic values of t and m in Canada suggest a simple multiplier that is closer to 1 than to
In the presence of taxes, the marginal propensity to consume out of national income is _______ the marginal propensity to consume out of disposable income.
a) equal to
b) greater than
c) less than
d) either greater or less than
c) less than
- Assume a net tax rate, t, so that net tax revenues are t percent of national income.
T = tY
Disposable income = YD = Y – T = Y – tY
YD = Y – tY
YD = (1 – t)Y
Given a consumption function C = 50 + (0.7)YD, which tells us that the MPC out of disposable income is 0.7.
C = 50 + (0.7)YD
C = 50 + (0.7)(1 – t)Y
(0.7)(1 – t) < (0.7), when (0 < t ≤ 1)
Hence, in the presence of taxes, the marginal propensity to consume out of national income is less than the marginal propensity to consume out of disposable income.
The marginal propensity to spend out of national income is less than the marginal propensity to consume out of disposable income because some national income is collected as
taxes and some national income is spent on
imports
What is the magnitude of stabilization policy so difficult to determine?
a) actual GDP may be higher tha npotential GDP
b) cyclical unemployment is impossible to measure
c) structural and frictional unemployment are always present
d) the gap between actual and potential GDP is uncertain
d) the gap between actual and potential GDP is uncertain
- Once we know the direction in which the government wants to change national income, the directions of the required changes in government purchases or taxation are easy to determine. But the timing and magnitude of the changes are more difficult issues. The issue of timing is difficult because it takes an uncertain amount of time before fiscal policies have an effect on real GDP.
Cyclical unemployment can be measured and while it is true that structural and frictional unemployment are always present, this does not explain why determining the magnitude of policy change is so difficult. When actual GDP is higher then potential GDP, the result is an inflationary gap. Closing the gap requires stabilization policy, but again, determining the magnitude of the policy change required is difficult.
MPC = 0.75
t = 0.125
m = 0.1
The simple multiplier without government and foreign trade is __________.
The simple multiplier with government and foreign trade is __________.
b) 4.00; 2.25
1 / (1 – MPC) = 1 / (1 – 0.75) = 1 / 0.25 = 4.00
The simple multiplier with government and foreign trade:
1 / (1 – [MPC(1 – t) – m]) = 1 / (1 – [0.75(1 – 0.125) – 0.1])
= 1 / (1 – 0.55625) = 1 / 0.44375 = 2.25
