Chapter 13

Question 1

Explain the difference between contractionary fiscal policy and expansionary fiscal policy

Answer 1

-fiscal policy affects the economy by increasing or decreasing aggregate demand

Question 2

How does government spending in fiscal policy affect the aggregate demand

Answer 2

It directly affects G
-an increase in government spending will generally shift the demand curve out to the right and a decrease will shift it in to the left

Question 3

How does tax policy in fiscal policy affect the aggregate demand

Answer 3

• directly affects C

- consumption depends on disposable income

Question 4

How does an increase in tax rate affect individuals and how will it shift the aggregate demand curve

Answer 4

Workers will take home less disposable income and we can expect them to reduce their consumption. As a result the aggregate demand curve shifts to the left

Question 5

What happens to individuals if the tax rate decreases and how will it shift aggregate demand

Answer 5

Workers will take home more money and consume more. The aggregate demand curve will curve out to the right

Question 6

What is expansionary fiscal policy

Answer 6

It describes the overall effect of decisions about government spending and taxation intended to increase aggregate demand

These shift the aggregate demand curve to the right

Question 7

What is contractionary fiscal policy

Answer 7

When the overall effect of decisions about government spending and taxation intended to decrease aggregate demand

-cause the demand curve to shift in to the left

Question 8

Explain how fiscal policy can counteract short-run

Answer 8

When the economy is sluggish,the government can conduct expansionary fiscal policy to stimulate demand which leads to a faster recovery

If the economy is overheating, the government can undertake contractionary fiscal policy to reduce aggregate demand which returns the economy closer to the long-run equilibrium

Question 9

Identify the time lags that complicate the formulation of fiscal policy and define time lags

Answer 9

Time lags mean that sometimes a fiscal policy choice is too late to do any good. There are information, formulation, and implementation lags

Question 10

What are information lags

Answer 10

How long it takes to get the right information about the overall health of the economy

Question 11

What are formulation lags

Answer 11

Getting everyone to agree on the right policy

Question 12

What are implementation lags

Answer 12

How long it takes fiscal policy to have an effect on the economy

Question 13

How can stabilizers automatically adjust fiscal policy as the economy changes

Answer 13

To get around time lags, automatic stabilizers can affect fiscal policy without specific action from policy makers. These can automatically stimulate or slow the economy

Question 14

What affect do automatic increased taxes have

Answer 14

The have a contractionary effect by slightly reducing spending and aggregate demand

Question 15

What do automatically reduced taxes have

Answer 15

An expansionary effect, encouraging spending and increasing aggregate demand

Question 16

How can government spending act as an automatic stabilizer

Answer 16

When the economy is booming, fewer people are eligible for employment insurance benefits and welfare programs so government spending falls and aggregate demand is reduced having a contractionary effect

In a recession, more people are eligible for these programs and spending on them rises, increasing aggregate demand and having an expansionary effect

Question 17

What is Ricardian equivalence

Answer 17

It predicts that if governments cut taxes but not public spending, people will recognize that the government will have to borrow money to cover the financial shortfall

The theory says that tax cuts will have no impact on spending: people will continue to save rather than spend, consumption will not decrease, and the tax cut will be unsuccessful in changing aggregate demand

Question 18

Describe how revenue and spending determine a government budget and how the budget deficit occurs

Answer 18

A deficit occurs when the government spends more than it collects in revenue. They increase during recessions

A surplus occurs when the government collects more than it spends

Question 19

Explain the difference between the government deficit and debt

Answer 19

Deficits occur when annual spending is more than annual revenue

The budget deficit tells us how much the government borrows each year

The debt tells us the total that the government has borrowed and not yet paid back over time
(The cumulative sum of all deficits and surpluses)

Question 20

What are treasury securities and why do people value them

Answer 20

The government borrows money from others by selling treasury securities which are debt-financing arrangements made by the Canadian government with obligations to pay back money over varying lengths of time

People buy treasuries as financial investments because the are seen as safe investments

Question 21

Identify the benefits and costs of government debt

Answer 21

Allowing the government to run a deficit permits the government to undertake expansionary fiscal policy

The costs are that interest needs to be paid, the government might not spend the money efficiently, and high deficits may affect interest rates and reduce investment

Question 22

What is the best fiscal policy for a country suffering from high inflation

Answer 22

Contractionary