Chapter 22

Question 1

purchases of goods and services by the government (G) does what for the economy?

Answer 1

it is adding directly to the demand for the economys current output of goods and services.

Question 2

how do transfer payments affect the economy

Answer 2

affects desired AE but only through the effect these transfers have on households income (indirectly through impacting income)

Question 3

what is part of desired aggregate expenditures (not including transfer payments)?

Answer 3

only G

Question 4

G is autonomous with respect to what

Answer 4

Y

Question 5

def. net taxes (T)

Answer 5

total tax revenues net of transfer payments

**assume given by T= t*Y
where t is the net tax rate

Question 6

describe the characteristics of net taxes formula

Answer 6

• As Y rises, a tax system with given tax rates will yield more revenue (net of transfers).
• Assume that the tax rate is an autonomous policy variable.
• With t we represent a complex tax and transfer structure

Question 7

def. budget balance

Answer 7

difference between G and T (ignoring debt-service payments)

Question 8

if G< T: a budget _____

Answer 8

surplus

The government uses the excess revenue to buy back outstanding government debt

Question 9

if G > T: a budget _______

Answer 9

deficit

The government must borrow the excess of spending over revenues. It does this by issuing additional government debt
(bonds or treasury bills).

Question 10

when measuring the overall contribution of government to desired aggregate expenditure, do all levels of government need to be included?

Answer 10

• yes
• particularly important in Canada
• combined purchases of provincial and municipal governments are large than those of the federal government

Question 11

What are the 4 key things to remember when thinking about government and taxes?

Answer 11

1. All levels of government add directly to desired AE through their
   purchases of goods and services (G).
2. G will be treated as an autonomous expenditure in our model.
3. Net tax revenues (T) is positively related to Y.
4. T will enter the AE function indirectly, through its effect on disposable income (YD). Recall: YD = Y - T.

Question 12

What are the two central assumptions we make when considering net exports?

Answer 12

1. Canada’s exports are autonomous with respect to Canadian GDP
2. Canada’s imports rise as Canadian GDP rises

Question 13

What is the formula for imports?

Answer 13

IM=mY

*where m is the marginal propensity to import

Question 14

net export formula

Answer 14

NX= X - mY

• *changes in domestic GDP lead to changes in net exports:
• -as Y rises, NX falls
• -as Y falls, NX rises

Question 15

what is held constant when drawing the NX function?

Answer 15

• foreign GDP
• domestic and foreign prices
• the exchange rate

Question 16

Describe the two main reasons for shifts in the net export function and what they cause

Answer 16

1. An increase in foreign income leads to more foreign demand for Canadian goods:
   - -increases X and shifts NX function upward
2. A rise in Canadian prices (holding foreign prices constant):
   - -decreases X
   - -IM function rotates up as Canadians switch toward foreign goods
   - ->NX function shits down and gets steeper

Question 17

what is the expanded AE function?

Answer 17

AE= [a + I + G + X] + {b(1-t) - m]Y

Question 18

What is the marginal propensity to spend with taxes and trade?

Answer 18

z=b(1-t)-m
z= MPC (1-t)-m
**is the slope of the AE function

Question 19

What is the equilibrium condition?

Answer 19

equilibrium Y occurs where desired aggregate expenditure equals actual national income

Question 20

What is the Saving-Investment approach to equilibrium in an open economy with government?

Answer 20

National Savings = National Asset Formation

S+(T-G)= I + (X- M)

Question 21

What is the Saving-Investment approach in equilibrium with wealth?

Answer 21

Y-AE= W

Question 22

describe intuition with the simple multiplier with taxes and imports

Answer 22

The presence of imports and taxes reduces the marginal
propensity to spend out of national income and thus reduces the value
of the simple multiplier

• the higher the m, the lower the simple multiplier
• the higher the t, the lower the simple multiplier

Question 23

What is the simple multiplier with gov and foreign trade?

Answer 23

1/ (1-[MPC(1-t)-m])

Question 24

def, fiscal policy

Answer 24

the use of the government’s spending (G) and tax policies (t) w
**Goal: stabilization policy

Question 25

def. stabilization policy

Answer 25

any policy that attempts to stabilize Y at or near Y*

**often clear in which direction fiscal policy should be adjusted, less clear how much is necessary

Question 26

Expected effects of fiscal policy:

Answer 26

1. A change in G –> shifts AE–> multiplier in motion–>changes equilibrium Y
2. a change in t –> changes the slope of AE—> changes in equilibrium Y

Question 27

What are the different effects of changing the net tax rate?

Answer 27

1. a lower t causes the AE function to become steeper

2. a higher t causes the AE function to become flatter

Question 28

when is the assumption of a constant price level reasonable?

Answer 28

1. When output is below potential, firms can increase output without increasing their costs.
2. When firms are price setters they often respond to shocks by changing output (and only later changing their price).