Chap. 8 - Fiscal Policy Flashcards
What is Discretionary Fiscal Policy?
It refers to the deliberate manipulation of taxes and government spending by Congress to alter real output and employment (thus impacting economic growth) and to control inflation.
What are the two terms when the government tries to increase output and reduce unemployment, and when it tries to lower inflation?
Expansionary
Contractionary
Which fiscal policies would be recommended during a recession?
There are two policies that would be expansionary (think of shifting the Aggregate Demand curve to the right): the first would be a decrease in taxes and the second would be an increase in government spending.
Let’s say that the government decides to reduce taxes by one million dollars. When consumers are informed that their taxes are going down by one million dollars, they will find that they now have one million dollars that they thought they were going to have to pay in taxes that they are actually going to be allowed to keep. In many ways, this will seem to them like a one million dollar increase in income. How much of the one million dollars will they actually spend?
This depends on the MPC. For example, if the MPC is equal to .8, consumers will spend $800,000 when their taxes are reduced by one million dollars. What will they do with the other $200,000? They will save it, because if their MPC is equal to .8, their MPS is equal to .2.
If there is a shift in AD to the right by $4 million in the Keynesian Range, what is the effect on Real GDP?
Real GDP increases by $4 million. Price level isn’t affected. Government can do an Expansionary Policy without affecting prices.
If there is a shift in AD to the right by $4 million in the Intermediate Range, what is the effect on Real GDP?
Horizontally there is a shift of $4 million in Real GDP, but because C, I, NX are affected by rising price level, the equilibrium point moves up where AD = AS, thus the net effect of the move isn’t actually $4 million, it is less than that.
In the case of both the AD intersecting AS in the Keynesian Range and in the Intermediate Range, expansionary fiscal policy reduces ___________ because it ______ real GDP.
Unemployment
Increases Real GDP
In the case where AD is in the intermediate range the increase in government spending or reduction in taxes will cause ______.
Inflation
What are some fiscal policies that would be contractionary?
Government wants to reduce inflation so they could reduce government spending or increase taxes.
In the Keynesian Range _______ is not an issue
Inflation
What are some ways that government can finance a deficit?
Borrow
The Fed loans to the government by buying bonds
What are some ways fiscal policy can affect the supply side?
fiscal policies geared toward building infrastructure such as roads, bridges, airports, etc., can impact the future productive capacity of the economy and stimulate long-run economic growth. In short, certain types of government spending can influence the ability of the AS curve to shift to the right over time. On the tax side of fiscal policy, we can influence the long-run growth of the economy by the work incentives that our tax codes either stimulate or reduce in families and the productive incentives that our tax codes can either stimulate or reduce in firms.
Describe the Laffer Curve
Laffer Curve depicts the impact of tax rates on tax revenues. The y axis there is Tax Revenue, and the x axis there is Tax Rate. The curve looks like an upside down parabola. Tax Revenues increase up to a certain point as tax rates increase then start to decrease as tax rates increase further.
