Questions for Week 5 Flashcards
(15 cards)
What is the balanced budget multiplier?
The balanced budget multiplier is the effect of equal changes in government spending and taxes, resulting in a net increase in output. Government spending directly increases demand, while taxes indirectly influence spending through disposable income.
How does the balanced budget multiplier stabilize the economy?
It maintains a balanced budget while boosting aggregate expenditure, as government spending has a larger immediate effect than taxes, helping to close output gaps.
What are some limitations of fiscal policy as a stabilization tool?
Fiscal policy has implementation lags, potential crowding-out effects, and limited flexibility. It can be less effective for rapid responses and is constrained by political considerations.
Why is intergenerational consideration important for fiscal policy?
Future generations bear the burden of debt through potential tax increases or spending cuts. The “Future Fund” is an example, providing for future liabilities to reduce this burden.
Given PAE = 50 + 0.7Y, what is the equilibrium income and multiplier?
Equilibrium income (Y) is calculated as Y = 50 / (1 - 0.7) = 166.67, with a multiplier of 1 / (1 - 0.7) = 3.33.
If the tax rate (t) is 0.1, what is the marginal propensity to consume (MPC)?
With c(1 - t) = 0.7, solving for c gives c = 0.7 / 0.9 = 0.78.
How does a $10 decrease in investment affect equilibrium output?
The multiplier effect on output is ΔY = 1 / (1 - 0.7) × (-10) = -33.33. If initial output was 166.67, the new output is 133.33, creating an output gap of -33.33.
How much should the tax rate be lowered to restore the initial output of 166.67?
To restore output, set PAE = 40 + c(1 - t’)Y = 166.67. Solving yields t’ = 0.026, requiring a tax rate reduction from 0.1 to 0.026.
How does a decrease in planned investment affect the economy’s recessionary gap?
With an MPC of 0.75 and a multiplier of 4, the contractionary gap is four times the reduction in planned investment.
Why might a tax change be less effective than government spending in closing a recessionary gap?
Tax cuts increase disposable income, but only part of it is spent due to the MPC. Government spending fully impacts aggregate demand, making it more effective in offsetting a decrease in investment.
How do automatic stabilizers like proportional taxes work to stabilize the economy?
Automatic stabilizers reduce fluctuations by adjusting with income changes. When income falls, tax revenue decreases automatically, increasing disposable income and supporting demand.
How does making taxes proportional to income affect the multiplier?
Proportional taxes reduce the multiplier, as part of the income is automatically adjusted, reducing the overall spending response to changes in aggregate demand, thus stabilizing the economy.
For a four-sector model with C = 400 + 0.8(Y - T), what is the algebraic expression for equilibrium output?
Equilibrium output Y is given by Y = (400 + I_p + G + NX) / (1 - c(1 - t)), where t is the tax rate and c is the MPC.
Calculate equilibrium output and the multiplier if X = 0, M = 0, MPC = 0.8, and t = 0.25.
The multiplier = 1 / (1 - 0.8(1 - 0.25)) = 2.5. Substitute values to find equilibrium output.
What determines a country’s level of public debt according to the government budget constraint?
Public debt is influenced by budget deficits, interest rates, and the growth rate of output. A rising real interest rate or decreasing growth increases debt burdens relative to GDP.
