Chapter 11
Presentation 2
Quick Review #1
• Suppose consumption is $400 and that the MPC
is 0.8. If disposable income increases by $1200,
consumption spending will increase by
• A. $1600
• B. $1360
• C. $1200
• D. $960
• E. $400
• Answer D
Quick Review #2
• An increase in personal income taxes will most
likely cause AD and AS to change in which of the
following ways in the short run?
•
AD
AS
• A. Not change
Decrease
• B. Not Change
Increase
• C. Decrease
Not Change
• D. Decrease
Increase
• E. Increase
Not Change
• Answer: C
Quick Review #3
• When the value of the US dollar appreciates
relative to other currencies, which of the
following is most likely to occur?
• A. Imports into the US will decrease
• B. Exports from the US will increase
• C. US residents will take more vacations in
foreign countries
• D. More foreign visitors will travel to the US
• E. Investments in US securities will increase
Discretionary v. Non-Discretionary
• Discretionary Spending- changes in spending
and taxes that are through government action
• Non-Discretionary Spending- changes that
occur without Congressional action
Built-In Stabilizer
• Anything that increases the government’s
deficit during a recession and increases its
surplus during an expansion without
government action
• ***the tax rates are set, and as output
expands, tax revenues go up
Built-In Stability
• As GDP increases, taxes will yield more
revenue for the government
• When GDP expands, individuals and
businesses pay more taxes
• As GDP falls, unemployment and welfare
increase (transfer payments)
Built-In Stability
Government Expenses, G
and Tax Revenues, T
T
Surplus
G
Deficit
GDP1
GDP2
GDP3
Real Domestic Output, GDP
Progressive Tax
• The average tax rate rises as income
increases, and decreases as income
decreases
• **as GDP rises, tax revenue rises
Regressive Tax
• The average tax rate falls as income and
GDP rise
Proportional Taxes
• The average tax rate remains constant as
income/GDP rise
Activity
• Congress has approved a new tax to fund
scientific research on clones. Everyone will
pay $1000.
• Classify this tax as progressive, regressive, or
proportional.
• Who would be in favor of this tax? Opposed?
• How could problems be corrected?
Problems With Fiscal Policy
• 1. Recognition Lag- the time between the
beginning of a recession/inflation and when
people become certain they are happening
• 2. Administration Lag- always a lag when
Congress needs to make a decision on policy
• 3. Operational Lag- time between when action
is decided on and when it goes into place
• Ex- planning for roads, dams etc.
Political Business Cycle
• Politicians often increase government
spending prior to an election and then slow
the economy after they are in office
Crowding Out Effect
• An expansionary fiscal policy may increase the
interest rate and reduce private spending,
which weakens or cancels the stimulus of the
expansionary policy
11-2
(Key Question)
• Assume that a hypothetical economy with an
MPC of .8 is experiencing severe recession. By
how much would government spending have to
increase to shift the aggregate demand curve
rightward by $25 billion? How large a tax cut
would be needed to achieve this same increase in
aggregate demand? Why the difference?
Determine one possible combination of
government spending increases and tax
decreases that would accomplish this same goal.
Answer 11-2 Key Question
• In this problem, the multiplier is 1/.2 or 5 so, the
required increase in government spending = $5
billion.
•
For the tax cut question, initial spending of $5
billion is still required, but only .8 (= MPC) of a tax
cut will be spent. So .8 x tax cut = $5 billion or tax
cut = $6.25 billion. Part of the tax reduction
($1.25 billion) is saved, not spent.
•
One combination: a $1 billion increase in
government spending and a $5 billion tax cut.