Chapter 12 - Fiscal Policy

Question 1

Definition of Fiscal Policy

Answer 1

Refers to government decisions about the level of taxation or government spending.
Affects economy by shifting Aggregate Demand (directly affects spending)

Question 2

Two channels to affect AD with fiscal policy

Answer 2

government spending and tax policy

Question 3

Definition of Expansionary Fiscal Policy

Answer 3

When the overall effect of decisions about taxation and spending is to increase aggregate demand.
Characterized by:
increasing government spending and lowering taxes
Shift AD curve to the right
Increased output, increased prices

Question 4

Definition of Contractionary Fiscal Policy

Answer 4

When the overall effect of decisions about taxation and spending is to reduce aggregate demand.
Decreased government spending and higher taxes both

Question 5

What is the main reason for policy makers to use fiscal policy?

Answer 5

to smooth fluctuations in the economy

Question 6

Keynesian economic policy

Answer 6

Using expansionary policy responses (such as increasd government spending and decreased taxes) to counteract a decreasing AD.
This leads to output and price levels rising.

Question 7

3 Different kinds of lag between policy choice and implementation

Answer 7

Information Lag
Formulation Lag
Implementation Lag

Question 8

Definition of Information Lag

Answer 8

There’s a lack of understanding in the current economy

Question 9

Definition of Formulation Lag

Answer 9

A discrepancy in deciding on and passing legislation

Question 10

Definition of Implementation Lag

Answer 10

The literal time it takes the economy to adjust

Question 11

Definition of Automatic Stabilizers

Answer 11

Are taxes and gov’t spending that affects fiscal policy without actual action from policy makers.

Question 12

Example of automatic stabilizers and why

Answer 12

Taxes because we have a progressive tax system. Ie) as your earnings rise, higher tax rates apply - affect Tax revenues
These take less time to implement.

Question 13

Definition of Discretionary Fiscal Policy

Answer 13

Self explanatory - when the government takes discretion when looking at the economy

ex) expansionary, contractionary fiscal policy

Question 14

Limitations of fiscal policy

Answer 14

Politicians often cut taxes in response to recessions; wealth effect - increasing consumption
Tax cuts aren’t free because the government must find a way to make up for lost tax revenue (most likely in the future).

Question 15

Definition of ‘Ricardian Equivalence’

Answer 15

Predicts that if there are tax cuts but no decrease in spending, people will not change their behaviour
This happens because the public knows they’ll have to pay later eventually.

Question 16

Definition of the Multiplier Effect

Answer 16

the increase in consumer spending that occurs when spending by one person causes others to spend more too. This amplifies the impact of the initial government policy on the economy.

Question 17

Things we need to do before deriving the multiplier

Answer 17

1) look at after tax income because that is each household’s consumption
2) people spend only a portion of their income

Question 18

Definition of Marginal Propensity to Consume

Answer 18

the amount by which consumption increases when after-tax income increases by $1
MPC is also a value between 0 and 1 - indicates the fraction of an additional dollar that gets spent.

Question 19

Example of MPC value of 0.8

Answer 19

MPS = 0.2
Multiplier = 1/MPS = 5
With an MPC of 0.8, we’re indicating that consumers spend 80% of their income and save 20%. This is key to know when indicating how much gov’ts need to put into the economy when trying to use expansionary fiscal policy to shift Aggregate Demand

Question 20

Definition of Taxation Multiplier

Answer 20

Indicates how much GDP changes when taxes increase by $1

Taxation multiplier = 1 less than Multiplier effect

Question 21

Definition of Transfer Payments

Answer 21

Refers to payments from gov’t accounts to individuals for programs like social insurance

Question 22

Definition of the Budget Deficit

Answer 22

the amount of money a government spends beyond the revenue it brings in. ie) spending more than than we earned.
ex) Running a deficit means we’re in the red fam

Question 23

Definition of the Budget surplus

Answer 23

The amount of revenue a government brings in beyond what it spends.

Question 24

What is the difference between debt and deficit?

Answer 24

Deficits tell us how much the government revenues have fallen short of spending each years.
Debt is the total amount that the government owes. Or, Debt is the cumulative sum of all deficits and surpluses.

Question 25

2 Main Benefits of Debt

Answer 25

1) allows the government to be flexible if something unexpected happens
2) Can pay for investments that lead to economic growth and prosperity

Question 26

Direct costs of debt

Answer 26

the interest governmenthas to pay to the people borrowed from
There’s a vicious cycle of debt - high interest rates

Question 27

Indrect costs of debt

Answer 27

distorts credit markets because everyone out here borrowing from everyone