Fiscal Policy + Foreign Trade

Question 1

Define Fiscal Policy

Answer 1

Government’s decisions on Spending + Taxes

Question 2

Define Stabilisation Policy

Answer 2

Government actions to try and keep Output close to its Potential level

Question 3

Define Budget Deficit

Answer 3

Excess of Government outlays over Government Receipts

Question 4

Define National Debt

Answer 4

Stock of Outstanding Government Debt

Question 5

How do Direct-proportional Taxes affect the Consumption Function?

Answer 5

They affect the SLOPE of the Consumption function

Hence, affecting the SLOPE of AD

Question 6

How does Gov. Expenditure + Lump-sum Taxes affect AD?

Answer 6

They affect the POSITION of AD

Question 7

In s Proportional Tax Regime, what is the function of Disposable Income in terms of the Net Tax Rate?

Answer 7

YD = (1 - t)Y

Disp. Income = Y(1 - NTR)

Question 8

What is the Equation for Y* under a Proportional Tax Regime?

Answer 8

Y = AD = C + I + G
=> Y = A + c (YD) + I + G
=> Y= A + c (1 - t)Y + I + G
Y* = {1 / [1 - c (1 - t)]} x {A + I + G}

Question 9

What are ‘c’ and c(1 - t) in the AD Equation under a Proportional Tax Regime?

Answer 9

c is the MPC out of Disposable Income

c(1 - t) is the MPC out of National Income

Question 10

As the Tax Rate Increases, what happens to the MPC?

Answer 10

MPC shrinks as Tax Rate Increases

Therefore, Increased t –> Lower Equilibrium Income, AD Schedule rotates downwards

Question 11

What does the Balanced Budget Multiplier say about an Equal rise in both Gov. Spending and Taxes?

Answer 11

It will lead to an Increase in Output

Question 12

What is the Consumption Function under a Lump-Sum Tax Regime?

Answer 12

C = A + c(Y - T)

Question 13

What are the AD and Y* Equations under a Lump-Sum Tax Regime?

Answer 13

Y = AD = C + I + G
=> Y = A + c (YD) + I + G
=> Y = A + c (Y - T) + I + G
Y* = [1 / (1 - c)] x [A + I + G - cT]

Question 14

What is the Function for a Gov. Budget Deficit?

Answer 14

G - NT

NT = Net Taxes

Question 15

Under a Lump-Sum Tax Regime, what happens to the Gov. Budget with a change in Income?

Answer 15

Nothing. Gov. Budget is Independent of Income

Question 16

Under a Proportional Tax Regime, what happens to the Gov. Budget with a change in Income?

Answer 16

Tax Revenues Increase with Income

Question 17

If Gov. Spending is Independent of Income (i.e. does not depend on income level) & Net Taxes Increase with Income, where is there a Budget Deficit and a Budget Surplus?

Answer 17

Budget Deficit- at Low Levels of Income

Budget Surplus- at High Levels of Income

Question 18

What is the purpose of Discretionary Fiscal Policy?

Answer 18

To Reduce Fluctuations in the Economy

Question 19

What policies make up Discretionary Fiscal Policy?

Answer 19

• Changes in Taxes

- Changes in Gov. Expenditure

Question 20

What are the 3 main Automatic Stabilisers?

Answer 20

High Tax Rates
High VAT Rates
Increased Unemployment Benefits in Recession

Question 21

How do High Tax Rates Automatically Stabilise the Economy?

Answer 21

High Tax Rates–> Reduce Multiplier–> Reduce effects of Shocks on Output

Question 22

How do High VAT Rates Automatically Stabilise?

Answer 22

High VAT Rates–> Consumption reacts less to Positive Shocks in Income

Question 23

How do Increased Unemployment Benefits in Recession Automatically Stabilise?

Answer 23

Increased Unemployment Benefits in Recession–> Counteract effects of Negative Shock on Income

Question 24

What are the 5 main limits to Fiscal Policy?

Answer 24

1. Time Lags- takes Time to Implement + take Effect
2. Uncertainty
3. Induced Effects on Autonomous Demand
4. Budget Deficit- G > TR
5. Economy may be at Full Employment- Inflationary

Question 25

Define Trade Balance

Answer 25

Value of Net Exports, NX = (X - Z)

Question 26

Define Trade Deficit

Answer 26

Imports exceed Exports

Question 27

Define Trade Surplus

Answer 27

Exports exceed Imports

Question 28

What is the Equilibrium AD Equation with Foreign Trade?

Answer 28

Y = C + I + G + X - Z

Question 29

What assumptions do we make about Exports and Imports

Answer 29

Exports are Independent of Income

Imports Increase with Income

Question 30

What do the assumptions on Exports and Imports imply?

Answer 30

There is a: -Trade Deficit at Relatively High Income Levels

-Trade Surplus at Relatively Low Income Levels

Question 31

What is the AD Equation with Foreign Trade + Proportional Taxes?

Answer 31

Y = A + c(1 - t) + I + G + X - Z
=>Y = A + c(1 - t) + I + G + X - zY
=>Y = [A + I + G + X] + c(1 - t) -zY
Y* = [A + I + G + X] x (1 / [1 - c(1 - t) + z])

Question 32

What is the Marginal Propensity to Import (z)?

Answer 32

Fraction of Additional Income that Domestic Residents wish to spend on Additional Imports

Question 33

What is the effect of the MPZ on the Multiplier?

Answer 33

Higher the value of z–> Lower the value of Multiplier