Chapter 11

Question 1

what is key to the Keynesian economic model?

Answer 1

aggregate demand

Question 2

K: when does equilibrium occur?

Answer 2

when total spending equals current output; if total spending is deficient, depressed conditions will persist

Question 3

MPC

Answer 3

marginal propensity to consume

Question 4

how are multiplier and MPC related?

Answer 4

M = 1 / (1 - MPC)

Question 5

multiplier principle

Answer 5

• based on the idea that one individual’s expenditure becomes the income of another
• the size of the multiplier is based on the proportion of additional income that households choose to spend on consumption

Question 6

Keynes and economic instability - central idea

Answer 6

businesses will produce only the quantity of goods and services they believe consumers, investors, governments, and foreigners will plan to buy

Question 7

the primary tool of fiscal policy

Answer 7

the federal budget: government expenditures must be financed with either (1) taxes or revenues derived from sources or (2) borrowing

Question 8

K: expansionary policy

Answer 8

aka the government should increase its purchases of goods and services, cut taxes, or both

Question 9

K: restrictive fiscal policy

Answer 9

a reduction in government expenditures and/or an increase in tax rates such that the expected size of the budget deficit declines

Question 10

automatic stabilizers

Answer 10

government policies that work toward establishing automatic, self-correcting mechanisms

Question 11

examples of automatic stabilizers

Answer 11

unemployment compensation, corporate profit tax, progressive income tax

unemployment compensation taxes increase during booms and decrease during recessions while benefits decrease during booms and increase during recessions

Question 12

paradox of thrift

Answer 12

the idea that when many households simultaneously try to increase their saving, actual saving may fail to increase because the reduction in consumption and aggregate demand will reduce income and employment

Question 13

fiscal policy lags

Answer 13

1. difficulty in timing (forecasting lag and congressional policy lag and effect lag)
2. fiscal policy takes time to run its course
3. by the time fiscal policy takes effect, the economy may have already adjusted