Chapter 13

Question 1

Federal Budget

Answer 1

is the annual statement of the federal
government’s outlays and revenues.

Question 2

2 purposes of fed budget

Answer 2

1. To finance the activities of the federal government
2. To achieve macroeconomic objectives

Question 3

Fiscal policy

Answer 3

is the use of the federal budget to achieve
macroeconomic objectives, such as full employment,
sustained economic growth, and price level stability.

Question 4

gov budget surplus

Answer 4

revenues exceed outlays

Question 5

gov budget deficit

Answer 5

If outlays exceed revenues

Question 6

gov balanced budget

Answer 6

If revenues equal outlays

Question 7

Government debt

Answer 7

is the
total amount that the
government borrowing.
It is the sum of past
deficits minus past
surpluses.

Question 8

What are the effects of an income tax in the labour market

Answer 8

• changes full employment and potential GDP
• decreases supply of labour (shifts curve left) because the tax lowers the after tax wage rate
• Changes equilibrium
• when quantity of labour decreases potential gdp decreases and aggregate supply decreases

Question 9

Tax wedge

Answer 9

The gap created between
the before-tax and after-tax
wage rates

Question 10

tax wedge and taxes on expenditure

Answer 10

Taxes on consumption expenditure add to the tax wedge.
The reason is that a tax on consumption raises the prices
paid for consumption goods and services and is equivalent
to a cut in the real wage rate.

Question 11

Taxes and the Incentive to Save and Invest

Answer 11

• A tax on capital income lowers the quantity of saving and
  investment and slows the growth rate of real GDP

Question 12

real after-tax interest rate

Answer 12

• The interest rate that influence saving and investment when there is taxation
• The real after-tax interest rate subtracts the income tax
  paid on interest income from the real interest
• Taxes depend on the nominal interest rate. So the true tax
  on interest income depends on the inflation rate

Question 13

Laffer Curve

Answer 13

The relationship between
the tax rate and the amount
of tax revenue collected
- slopes up till T*, than slopes down
(till T rise in taxes will increase tax revenue after it will decrease)

Question 14

Fiscal Stimulus

Answer 14

• the use of fiscal policy to increase
  production and employment
• Can be Automatic or Discretionary.

Question 15

Automatic fiscal policy

Answer 15

fiscal policy action triggered
by the state of the economy with no government action

Question 16

Discretionary fiscal policy

Answer 16

a policy action that is
initiated by an act of Parliament.

Question 17

Two items in the government budget change automatically
in response to the state of the economy

Answer 17

▪ Tax revenues
▪ Outlays

Question 18

Automatic Changes in Tax Revenues

Answer 18

• Parliament sets the tax rates that people must pay.
• The tax dollars people pay depend on tax rates and incomes.
• But incomes vary with real GDP, so tax revenues depend on real GDP.
• When the real GDP increases in an expansion, tax revenues increase.
• When real GDP decreases in a recession, tax revenues decrease.

Question 19

Outlays

Answer 19

• The government creates programs that pay benefits to
  qualified people and businesses.
• These transfer payments depend on the economic state of
  the economy.
• When the economy is in an expansion, unemployment
  falls, so unemployment benefits decrease.
• When the economy is in a recession, unemployment rises,
  so unemployment benefits increase.

Question 20

Automatic Stimulus

Answer 20

• In a recession, tax revenues decrease and outlays increase.
• So the budget provides an automatic stimulus that helps shrink the recessionary gap.
• In a boom, tax revenues increase and outlays decrease.
• So the budget provides automatic restraint that helps shrink the inflationary gap.

Question 21

structural surplus or deficit

Answer 21

the budget balance that would occur if the economy were at full employment
and real GDP were equal to potential GDP

Question 22

cyclical surplus or deficit

Answer 22

• the actual surplus or
  deficit minus the structural surplus or deficit
• occurs purely because real GDP does not equal potential GDP

Question 23

Most discretionary fiscal stimulus focuses on its effects on …

Answer 23

aggregate demand

Question 24

Two main fiscal multipliers

Answer 24

• Government expenditure multiplier
• Tax multiplier

Question 25

government expenditure multiplier

Answer 25

• is the quantity effect of a change in government expenditure on real GDP
• if crowding out effect dominates multiplier is <1, and the consensus is that is the case

Question 26

tax multiplier

Answer 26

• the quantity effect a change in taxes
  on aggregate demand
• The supply-side effects of a tax cut probably dominate the demand-side effects and make the overall tax multiplier larger than the government expenditure multiplier

Question 27

Time Lags (3)

Answer 27

The use of discretionary fiscal policy is seriously
hampered by three time lags
1.) Recognition lag
2.) Law-making lag
3.) Impact lag

Question 28

Recognition lag

Answer 28

the time it takes to figure out that
fiscal policy action is needed

Question 29

Law-making lag

Answer 29

the time it takes Parliament to pass
the laws needed to change taxes or spending

Question 30

Impact lag

Answer 30

—the time it takes from passing a tax or
spending change to its effect on real GDP being felt