Los 14.c

Question 1

What are the main spending tools of fiscal policy?

Answer 1

Transfer payments: Payments like Social Security and unemployment benefits (not included in GDP).

Current spending: Routine government purchases of goods and services.

Capital spending: Investment in infrastructure (e.g., roads, bridges, schools) to boost future productivity.

Question 2

What are the goals of government spending tools?

Answer 2

Provide public services (e.g., national defense).

Invest in infrastructure to promote growth.

Support employment and GDP targets by affecting aggregate demand.

Provide a minimum standard of living.

Encourage investment in R&D (e.g., green technology).

Question 3

What are the revenue tools of fiscal policy?

Answer 3

Direct taxes: Income tax, corporate tax, capital gains tax, estate tax, wealth tax, etc.

Indirect taxes: Sales tax, value-added tax (VAT), excise taxes on specific goods (e.g., alcohol, tobacco).

Question 4

What are desirable attributes of a tax system?

Answer 4

Simplicity: Easy to use and enforce.

Efficiency: Minimize distortion of market forces.

Fairness:

Horizontal equity: Equal treatment for equals.

Vertical equity: Richer people pay more.

Sufficiency: Generate enough revenue to meet government needs.

Question 5

What are the advantages and disadvantages of fiscal policy tools?

Answer 5

Advantages:
Social policies (e.g., discouraging tobacco use) can be implemented quickly via indirect taxes.]
Quick implementation of indirect taxes also means that government revenues can be increased without significant additional costs.
Disadvantages:
Direct taxes, transfer payments, and capital spending take time to impact the economy.
Fiscal announcements can immediately affect expectations and consumption behavior.

Question 6

Which fiscal tools are most effective in boosting aggregate demand?

Answer 6

Government spending is more effective than tax cuts.

Tax cuts for low-income groups are more effective because they have a higher marginal propensity to consume (MPC).

Question 7

What is the fiscal multiplier and how is it calculated?

Answer 7

Fiscal multiplier measures how much aggregate demand changes from government spending.

Formula:

Multiplier = 1 / (1-MPC (1-t))

MPC = marginal propensity to consume and
t = tax rate.

Higher MPC → higher multiplier.

Higher tax rate → lower multiplier.

Question 8

What is the balanced budget multiplier?

Answer 8

If government increases spending and taxes by the same amount, aggregate demand still increases.

Example:

$100 spending and $100 tax increase results in a net $50 increase in aggregate demand (in the given example).**

Question 8

What is Ricardian equivalence?

Answer 8

When people expect higher future taxes from current deficits, they may increase current saving and reduce current consumption.

If they offset government spending completely, aggregate demand does not change.

If people underestimate future taxes, Ricardian equivalence does not hold, and stimulus still boosts demand.