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Quiz 18 :

International Trade Policy

Quiz 18 :

International Trade Policy

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During the Depression, unemployment rose to 25 percent. The AS / AD model presented in the book suggests that a fall in the price level would have solved the problem. Keynesians are not so convinced and believe that a fall in the price level would havea. Demonstrate the standard argument graphically. b. How does it deal (or not deal) with that interconnection between a fall in the price level and aggregate demand? (Post-Keynesian)
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Fiscal policy is the tool used by government to control and manipulate the economy. The main tools of fiscal policy are tax rates and government purchases. The government can have either contractionary policy or expansionary policy.
a.Show the AS-AD diagram as follows: img In the graph above, it can be seen that when there is decrease in aggregate demand then the demand curve will shift to the left which will decrease the as well as output. And decrease in output reduces employment further.
b.When the demand curve shifts to its left then the real GDP decreases, which means that the overall production of the economy has decreased. When production has decreased then the labor demand will also decrease which will cause higher unemployment rate.

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According to the Ricardian equivalence theorem, what is the effect of deficit spending on each of the following: a. The interest rate and private investment. Demonstrate your answer using the supply and demand forb. Output in the economy. Demonstrate your answer with the AS / AD model.
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(a) According to the Ricardian equivalence theorem, there would be no effect of deficit spending on the interest rate and private investment. This implies that even if government finance it is spending by selling bonds there would be no increase in interest rates and thus there would be no crowding out of private investment.
Following figure shows the market forAs above figure shows, initiallyNow, government finance it is spending by selling bonds, this selling of bonds implies rise in demand forAs Ricardian equivalence theorem states that if government finance current spending by running deficit that is by selling bonds then, in future, it have to raise taxes so that it can have necessary resources to pay for the interest on the bonds and to repay the bonds when they came to maturity. Furthermore, to pay for the increased taxes in future, people will now consume less and would save more. These savings in anticipation of future taxes will meet the rise in demand forNew equilibrium is attained at point B, where interest rate is R percent per year and quantity ofThus, interest rate has remained same.Since, interest rate has remained same, no crowding out effect has happened and therefore private investment will remain same.(b) According to Ricardian equivalence theorem, there would be no effect of deficit spending on the output in the economy.
This happens because all income accruing to the households and firms from the debt financed government expenditure will be saved in anticipation of future tax burden and thus does not lead to increase in demand for goods and services by households and firms and therefore output in the economy remains same and there is no expansion of aggregate demand.Following figure shows the Goods market - img As above figure shows, initially output in the economy is Y. Now, government increases its spending by running deficit that is by selling bonds. This selling of bonds by government to meet its current spending implies that in future taxes will be raised so that necessary resources could be generated to pay the interest on bonds as well as bonds upon maturity. This anticipation of increase in taxes in future will compel the people to decrease their current consumption and increase their current savings so that they would be able to pay the high taxes in future. Thus, increase in government spending will exactly be offset by the equivalent decrease in private spending and hence aggregate demand or aggregate expenditure will remain same and therefore output in the economy remains same.This shown in the above figure by the rightward shift of the aggregate demand curve from AD to AD 1 due to increase in government spending and then back to AD itself due to equivalent decline in private spending.
So, output in the economy has remained same.

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What is functional finance?
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FUNCTIONAL FINANCE -
Theory of Functional Finance states that while making spending and taxation decision, government should focus on their effect on the economy as a whole rather than basing its spending or taxing decisions on some moral principles that suggest that government should run balance budgets.
This theory suggest that government should run deficit, if aggregate expenditure in the economy is tooMoreover, functional finance theory acknowledges government budget balance as steering wheel with which economy should be controlled and it is the state of economy that should influence the decision of government to have deficit or surplus.

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Explain the place of activist fiscal policy in directing the economy according to each of the following points of view: a. Sound finance. b. Functional finance.
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The economy has often been far from full employment. a. What would it take to run a regime of continuous full employment? b. How would the establishment of a full employment regime alter the relations between workers and capitalists? c. Is such a regime politically feasible? (Radical)
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President Bill Clinton's policy in 1993 was designed to reduce the deficit but increase employment. a. Why would such a policy not fit well in the multiplier model? b. Explain in words how such a policy might achieve the desired effect. c. Graphically demonstrate your answer in b. d. What data would you
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According to the Ricardian equivalence theorem, why is government spending offset by a reduction in private spending?
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In this chapter you learned the importance of automatic stabilizers. At the state level, "rainy day" funds play a crucial role in maintaining services when state revenues decrease during a recession. While this may appear to be a rational institution, institutions are social constructs and what appears rational depends upon individual belief systems. The existence of a rainy-day fund can be interpreted as definitive proof of excess taxation and, in states that allow voter referendums, this fund can be eliminated by a majority vote. What vested interests- those seeking something for nothing-benefit from such decisions? (Institutionalist)
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Any policy has both advantages and disadvantages, implying that policy makers must weigh both the advantages and disadvantages when deciding what policy to follow. a. Does society share absolute, objective values that guide the weighing of the alternatives? b. What role should religious beliefs play in establishing these values? (Religious)
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Demonstrate the effect of the following on output and the price level in the AS / AD model and on the interest rate and investment in using the supply and demand fora. Full crowding out. b. Partial crowding out. c. Full crowding out and private investment is more productive than government investment.
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When Professor Robert Gordona. What events in the 1990s most likely motivated his revision of the target unemployment rate? b. Show the effect this revision would have on the AS / AD model. c. The unemployment rate at the time of the revision was 5.5 percent. Income was $7.3 trillion. Within 18 months the unemployment rate had fallen to 5 percent without signs of accelerating inflation. How much higher would the level of potential income have been in 1995 if the target unemployment rate were 5 percent rather than 5.5 percent?
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If interest rates have no effect on investment, how much crowding out will occur?
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Why does sound finance not depend on the Ricardian equivalence theorem?
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It is often argued that savings should be encouraged. If one believes in the free market, does encouraging savings make sense? Why or why not? (Austrian)
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Use the AS / AD model to explain why most presidents advocate government spending programs when running for reelection.
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Congratulations! You've just been appointed chairman of the Council of Economic Advisers in Textland. The mpe is.8. There is a recessionary gap of $400. a. The government wants to eliminate the gap by changing expenditures. What policy would you suggest? b. Your research assistant comes running in and tells you that instead of changing expenditures, the government wants to achieve the same result by decreasing taxes. What policy would you recommend now? (Requires reading and using the math in Appendix A of the chapter "The Multiplier Model.") c. Your research assistant has a worriedd. She still has a pained expression, "What's wrong?" you ask. "You didn't let me finish," she says. "Not only was there a marginal tax rate of.2; there's also a marginal propensity to import of.2." Again you interrupt to make sure she doesn't feel guilty. Again you say, "No problem," and recalculate your answers to parts a and b to account for the new information. What are your new answers? (Requires reading Appendix A of the chapter "The Multiplier Model.") e. That pained
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How does the budget process make fiscal policy difficult to implement?
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Use the AS / AD model to explain the maxim in politics that if you are going to increase taxes, the time to do it is right after your election, when reelection is far off.
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According to crowding out, how is government spending offset by a reduction in private spending?
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Why is functional finance difficult to implement?
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