Answers to Questions in Chapter 17

Answers to in-text Questions in Chapter 17
500  The withdrawals functions in Figure 17.2 were based on the assumption that the marginal rate of tax,
although higher in economy 2, was nevertheless constant in each case. Redraw the diagram, only this
time assume that the marginal rate of tax in economy 2 increases. How will this affect the stabilising
properties of the tax?
If we were to redraw the curve so that the marginal tax rate increased, then the curve would become
steeper as national income (Y) increased. The stabilising properties of the tax would increase as a result.
501  Show the effect of an increase in government expenditure by using the income/expenditure diagram.
Refer back to Figure 16.13 on page 484 of the text. The increase in government expenditure shifts the
total expenditure line from E1 to E2, thereby leading to a multiplied rise in national income from Ye1 to Ye2.
502  Why will the multiplier effect of government transfer payments such as child benefit, pensions and social
security be less than the full multiplier effect given by government expenditure on goods and services.
Will this ‘transfer payments multiplier’ be the same as the tax multiplier? (Clue: will the recipients of
such benefits have the same mpcd as the average person?)
The ‘transfer payments multiplier’ will be smaller than the government expenditure multiplier, because
part of transfer payments is not spent on domestic goods: some is saved, some goes in taxes and some is
spent on imports.
The transfer payments multiplier, however, will probably be larger than the tax multiplier. The reason
is that the marginal propensity to save from transfer payments will probably be lower than from incomes.
This is because transfer payments are paid proportionately more to poorer people, who have a low mps.
503  (Box 17.1) What effects will government investment expenditure have on public-sector debt (a) in the
short run; (b) in the long run?
(a) Increase. Unless financed by extra taxation, an increase in government expenditure (for whatever
purpose) will lead to an increase in public-sector debt.
(b) Possibly decrease. If the investment leads to extra output and income, then the extra tax revenue from
the extra incomes and expenditure could more than offset the cost of the investment, thereby leading
to a fall in public-sector debt.
505  (Box 17.2) By looking through recent press articles, attempt to establish the current fiscal stance of the
various EU governments.
You will need to look both at government claims, the specific actions taken by governments and how the
balance between government expenditure and taxation affects the overall balance of injections and
withdrawals (see pages 498–9).
506  How do people’s expectations influence the outcome?
People’s expectations will reinforce whatever it is they expect. If firms expect a rise in government
expenditure to lead to higher interest rates, a reduction in private-sector investment and hence no
expansion of the economy, they will reduce their investment plans, thus bringing about the effect (i.e.
economic stagnation) that they had anticipated.
Answers to questions in Economics (4th edition) by John Sloman
506  Do theories of the long-run and short-run consumption functions help us to understand consumer
reactions to a change in taxes?
If consumption is less responsive to changes in disposable income in the short run than in the long run,
then tax changes will have less effect on consumption (and hence a smaller multiplier effect) in the short
run than in the long run.
507  (Box 17.3) If tax cuts are largely saved, should an expansionary fiscal policy be confined to increases in
government spending?
Under these conditions, increases in government spending, provided they are direct expenditure on outputgenerating activities, will be more effective than tax cuts in stimulating a recovery.
 Give some examples of these random shocks.
Changes in international (and hence national) interest rates; a war in the Middle East and hence a sudden
rise in oil prices; a crisis in Asia or in the US economy, which pushes the world into recession; an
unpredictable rise in industrial disputes; a political crisis at home.
509  (Box 17.4) 1. Could you drive the car at a steady speed if you knew that all the hills were the same length
and height and if there were a constant 30-second delay on the pedals?
Yes. You would simply push on the accelerator (or brake) 30 seconds before you wanted the effect to
occur. You would do this so that the car would end up braking as you went down hill and accelerating as
you went up hill.
The lesson for fiscal policy is that if forecasting is correct, if you know the precise effects of any fiscal
measures, and if there are no random shocks, then fiscal policy can stabilise the economy.
 (Box 17.4) 2. What would a fixed throttle approach to fiscal policy involve?
It could either involve setting targets for the PSBR (or PSDR) or budget deficit (or surplus), which would
be stuck to, irrespective of what happened to the economy. The problem with this is that it would remove
any automatic stabilising effects of fiscal policy.
An alternative is to set targets for the PSBR (or PSDR) or budget deficit (or surplus) that vary with the
level of unemployment, or some other measure of the degree of slack in the economy. Thus the greater
the slack, the bigger would be the target deficit. This would then build in an automatic stabilising element.
The more the economy expanded, and slack was taken up, the more the deficit would be reduced (or
surplus increased), thereby dampening the growth in aggregate demand.