Fiscal Policy

Question 1

Fiscal Policy

Answer 1

Government’s intervention w. govt purchases + taxes

Question 2

Multiplier Effect

Answer 2

1) Each dollar spent by govt raises ag. demand by more than a dollar
2) Because govt spending –> more profit/employment –> increased individual spending (multiplies)

Question 3

What is investment accelerator

Answer 3

higher govt spending –> higher demand for investment goods

Question 4

Marginal Propensity to Consume

Answer 4

1) Fraction of extra income household consumes instead of saving
2) ex = MPC = 3/4 –> for every extra $1 household gets, spend $.75

Question 5

Equation for multiplier

Answer 5

1/(1-MPC)
small change can have a big effect

Question 6

Crowding out Effect

Answer 6

1) reduction in aggregate demand that results when fiscal expansion raises interest rate
2) increase in govt purchases –> workers get more money –> increases money demand –> causes interest rate to rise –> pushes ag demand left

Question 7

How do tax increases/decreases shift aggregate demand

Answer 7

1) Tax cut –> shifts aggregate demand right
2) Tax increase –> shifts aggregate demand left
money multiplier + crowding out applies

Question 8

How does perception of tax cut affect shift in aggregate demand

Answer 8

1) If viewed as permanent –> will considerably shift aggregate demand
2) If viewed as temporary –> not as much

Question 9

What should fed do to stabilize economy + employment (active involvement)

Answer 9

1) Remove punch bowl right before party starts
2) ESSENTIALLY –> during periods of pessimism –> expand aggregate demand by infusing money + during periods of optimism –> contract aggregate demand by reducing money supply

Question 10

Why do some economists advocate against monetary/fiscal policy

Answer 10

1) monetary policies operate with long lag –> takes at least 6 months to have effect on employment
2) fiscal policy –> takes lag bc of political process (going through house + senate)
3) lags problematic bc economic forecasting is imprecise

Question 11

Automatic stablizers

Answer 11

1) Changes in fiscal policy that stimulate aggregate demand when economy goes into recession without deliberate action from policymakers
2) Ex: Tax system + govt spending

Question 12

How is the tax system an automatic stablizer

Answer 12

1) When economy enters recession –> tax collections decline bc tied to economy activity –> tax cut stimulates ag. demand

Question 13

How is govt spending an automatic stablizer

Answer 13

1) Recession –> people lose jobs –> need unemployment + insurance benefits –> increased govt spending –> Ag demand shifts right