Module 6

Question 1

What is Fiscal Policy?

Answer 1

The government’s adjustment of taxation and public spending

Question 2

Does Fiscal Policy affect aggregate supply or demand?

Answer 2

Fiscal policy affects the economy by increasing or decreasing aggregate demand. This, in turn, translates into higher/lower output or prices in the economy

Question 3

How does government spending affect aggregate demand?

Answer 3

Government spending directly affects GS in the equation for AD, and it can indirectly affect consumption or investment through multiplier effect or crowding out

Question 4

How does taxation affect the AD equation

Answer 4

It directly affects C in the aggregate demand equation, so it will shift the AD curve right or left from decreases or increases in tax rates respectively. Since consumption depends on disposable income, the amount that the government takes off their initial paycheque determines how much they can spend

Question 5

What are the main lags that make fiscal policy ineffective in the real world?

Answer 5

Information, Formulation and Implementation act

Question 6

Difference of and examples of discretionary vs. automatic fiscal policy

Answer 6

Discretionary: policy that the government actively chooses to adopt. Stimmy plans are an example

Automatic stabilizers: policy that automatically takes effect in the economy without active involvement. Income tax and Unemployment insurance are examples

Question 7

What is the Ricardian equivalence?

Answer 7

According to Ricardian equivalence theory, rational people should save what they earn from tax cuts rather than spend it today, in order to meet future tax obligations

If people do choose to spend the money earned from tax cuts, then Ricardian equivalence WILL NOT HOLD, and the policy will be effective

Question 8

What are debt and deficit?

Answer 8

Deficit: the amount government revenues fall short of government spending ANNUALLY

Debt: the amount of money the government owes at a point in time. In other words, debt is the CUMULATIVE sum of all deficits and surpluses

Question 9

Who bears the burden of government debt

Answer 9

The increased government spending and cut in taxes benefits the population today, but people TOMORROW will have to repay the loans. The costs of services are being kicked down to children, grandchildren and future generations

Question 10

Fiscal policy affects the economy through 2 channels. True or False?

Answer 10

True, because it affects government spending and taxation