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Macroeconomics Study Set 43

Business

Quiz 13 :

A: Fiscal Policy, Deficits, Surpluses, and Debt

Quiz 13 :

A: Fiscal Policy, Deficits, Surpluses, and Debt

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Give a brief definition of fiscal policy? What are its economic goals?
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Fiscal policy is the use of the government budgetary actions to achieve full employment, control inflation, and stimulate economic growth.The changes to the budget can be made through changes in government spending or taxes.

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Assume that without any taxes the consumption schedule for an economy is as shown in the table.Also assume that investment, net exports, and government expenditures do not change with changes in real GDP. img (a) What are the MPC, MPS, and the size of the multiplier? (b) Assume a lump-sum tax of $10 billion is imposed at all levels of GDP.Determine consumption and the tax rate at each level of GDP by completing the following table.Is tax regressive, proportional, or progressive? Compare the multiplier under the lump-sum tax with the pre-tax multiplier. img (c) Assume instead that a proportional tax of 10% is imposed at all levels of GDP.Determine consumption at each level of GDP by completing the following table.Compare the multiplier under the proportional tax with the multiplier under the lump-sum tax.Explain why a proportional or progressive tax system contributes to greater economic stability as compared with the lump-sum tax. img
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(a) The MPC is .8.(160/200).The MPS is .2 (1 - .8).The multiplier is 5 (1/.2).
(b) The lump-sum tax reduces disposable income by $10 billion.Since the MPC is .8, consumption at each level of GDP falls by $8 billion.
The lump-sum tax is a regressive tax because the average tax rate decreases as GDP increases.Since the after-tax MPC and MPS are unchanged, the multiplier under the lump-sum tax is the same as the pre-tax multiplier.
(c) Because the tax is 10% of GDP and the MPC is .8, consumption is reduced by the amount of the tax multiplied by .8.For example, when GDP is $800 billion, taxes are $80 billion and disposable income is reduced by $80 billion.This decrease in disposable income reduces consumption by $64 billion.
Under the proportional tax, the after-tax MPC is .72 ($144/$200).As a result, the after-tax MPS is .28 (1 - .72) and the multiplier is 3.57 (1/.72).Therefore, the multiplier is smaller.
Compared to a regressive tax system, a proportional or progressive tax system takes a smaller portion of low income and a bigger portion of high incomes.Thus, a proportional or progressive tax system leaves more disposable income for spending during low-income periods and less disposable income for spending during expansionary phases.As a result, any change in aggregate expenditures produces a smaller change in GDP.In other words, the multiplier is smaller and there is greater built-in stability under a proportional or progressive tax system.

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Which fiscal policy, government spending or taxes, is preferable?
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The answer depends on one's point of view and economic conditions.Those who believe that the government is too large and inefficient would favour a cut in taxes during recessions and cuts in government expenditures during periods of demand-pull inflation.On the other hand, those who believe that social and physical infrastructure are inadequate would favour increases in government spending during recessions and higher taxes in times of demand-pull inflation.

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During which phases of the business cycle would fiscal policies that reduce budget deficits (or even increase surpluses) be appropriate?
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Give two examples of contractionary fiscal policy.What will be the effect on government surplus/deficit?
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What does the "full-employment budget" measure and of what significance is this concept? (Note: full-employment budget and cyclically adjusted budget are synonyms.)
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Under a particular tax system, the government collects $80 billion in tax revenues when GDP is $800 billion and $88 billion when GDP is $900 billion.Is this tax system regressive, proportional, or progressive?
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If the government is not implementing a discretionary expansionary fiscal policy, how can its budget move into a deficit?
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Explain how the below graph illustrates the built-in stability of the tax structure. img
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In Year 1, the full-employment budget showed a deficit of $100 billion and the actual budget showed a deficit of $150 billion.In Year 2, the full employment budget showed a deficit of $125 billion and the actual budget showed a deficit of $175 billion.Based on the data, what can be concluded about the direction of fiscal policy and the performance of the economy between Years 1 and 2?
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Explain the aspects of expansionary and contractionary fiscal policy.During which phases of the business cycle would each be appropriate?
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Differentiate between discretionary fiscal policy and non-discretionary policy (or built-in stabilization).
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In Year 1, the full-employment budget showed a deficit of $100 billion and the actual budget showed a deficit of $150 billion.In Year 2, the full employment budget showed a deficit of $125 billion and the actual budget showed a deficit of $150 billion.Based on the data, what can be concluded about the direction of fiscal policy and the performance of the economy between Years 1 and 2?
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Give two examples of expansionary fiscal policy.What will be the effect on government surplus/deficit?
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"The more progressive a tax system, the greater is the economy's built-in stability." Explain this statement for both recessionary and peak phases of the business cycle.
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Evaluate: A tax system in which those with higher incomes pay more taxes is progressive.
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Explain what is meant by a built-in stabilizer and give two examples.
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Under a particular tax system, the government collects $40 billion in tax revenues when GDP is $800 billion and $45 billion when GDP is $900 billion.Is this tax system regressive, proportional, or progressive?
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In Year 1, the full-employment budget showed a deficit of $100 billion and the actual budget showed a deficit of $150 billion.In Year 2, the full employment budget showed a deficit of $75 billion and the actual budget showed a deficit of $100 billion.Based on the data, what can be concluded about the direction of fiscal policy and the performance of the economy between Years 1 and 2?
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Describe Canada's Economic Action Plan to combat the Great Recession of 20089 - 2009.
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