Macroeconomics Study Set 62

Business

Quiz 11 :

Managing Aggregate Demand: Fiscal Policy

Quiz 11 :

Managing Aggregate Demand: Fiscal Policy

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When the income-tax rate declines, as it did in the United States in the early 2000s, does the multiplier go up or down Explain why.
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Effect of reduction in income tax on multiplier
If income tax rate declines, the multiplier will go up. This is because the reduction in tax will increase the disposable income of the people. The increase in disposable income will increase the consumption level in the economy, which in turn induces the equilibrium level of GDP to increase. Thus, the reduction in income tax will cause the multiplier to go up.

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Which of the proposed supply-side tax cuts appeals to you most Draw up a list of arguments for and against enacting such a cut right now.
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Supply-side tax cuts
Supply-side tax cut refers to the tax cut that increases the aggregate supply.
The most appealing supply-side tax cuts and its support view
Income tax cut increases the incentive to work more. This in turn increases the supply of labor works, which increases the output.
Tax cut on the interest and dividends increases the investment on such assets. This increase in investment increases the employment and output.
Capital gain refers to the sale of assets for profit. Tax cut on the capital gains increases the investment, which in turn increases the output.
Tax cut on the corporate income tax gives more incentives to increase profit. To get more profit, investment will increase. This increase in investment leads to an increase in the income and output.
Critics of the supply-side tax cut
The historical evidence shows that the tax cut on interest and dividends fails to increase the investment in such assets.
The tax cut on income increases not only the working hours but also the disposable income, which increases the demand for goods and services. Hence, the impact of reducing income tax is not greater for the supply side but for the demand side.
The tax cut on capital gains and corporate income will take more time to realize the incentives since the returns from the investment will take more time. Hence, this fails to increase the investment.
This supply-side tax cut increases the income inequality. The supply-side tax cut gives more incentives to the rich people to increase the investment, which in turn increases the wealth of the rich persons.
This supply-side tax cut decreases the government revenue, which leads to an increase in the budget deficit since it involves huge tax amount.

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Return to the hypothetical economy in Test Yourself Question 1, and now suppose that both taxes and government purchases are increased by $120. Find the new equilibrium under the assumption that consumer spending continues to be exactly three-quarters of disposable income (as it is in Test Yourself Question 1). Reference Test Yourself Question 1 Consider an economy in which tax collections are always $400 and in which the four components of aggregate demand are as follows: img Find the equilibrium of this economy graphically. What is the marginal propensity to consume What is the multiplier What would happen to equilibrium GDP if government purchases were reduced by $60 and the price level remained unchanged
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Which of the following is considered a fixed tax and which a variable tax a. The gasoline tax b. The corporate income tax c. The estate tax d. The payroll tax
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Discuss the pros and cons of having a higher or lower multiplier.
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Now put yourself in charge of the economy in Test Yourself Question 2, and suppose that full employment comes at a GDP of $1,840. How can you push income up to that level
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The federal government spending (relative to the size of the economy) was cut back in several dimensions after the gigantic budget deficits of 2009 and 2010. How would GDP in the United States have been affected if this lower spending led to a. smaller budget deficits b. more spending elsewhere in the budget, so that total government purchases remained the same
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Consider an economy similar to that in the preceding question in which investment is also $200, government purchases are also $500, net exports are also $30, and the price level is also fixed. But taxes now vary with income, and as a result, the consumption schedule looks like the following: img Find the equilibrium graphically. What is the marginal propensity to consume What is the tax rate Use your diagram to show the effect of a decrease of $60 in government purchases. What is the multiplier Compare this answer to your answer to Test Yourself Question 1. What do you conclude
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(More difficult) Advocates of lower taxes on capital gains argue that this type of tax cut will raise aggregate supply by spurring business investment. Compare the effects on investment, aggregate supply, and tax revenues of three different ways to cut the capital gains tax: a. Reduce capital gains taxes on all investments, including those that were made before tax rates were cut. b. Reduce capital gains taxes only on investments made after tax rates are cut. c. Reduce capital gains taxes only on certain types of investments, such as corporate stocks and bonds. Which of the three options seems most desirable to you Why
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Explain why G has the same multiplier as I , but taxes have a different multiplier.
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( More difficult ) Suppose real GDP is $10,000 billion and the basic expenditure multiplier is two. If two tax changes are made at the same time: a. fixed taxes are raised by $100 billion, b. the income-tax rate is reduced from 20 percent to 18 percent, will equilibrium GDP on the demand side rise or fall
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Consider an economy in which tax collections are always $400 and in which the four components of aggregate demand are as follows: img Find the equilibrium of this economy graphically. What is the marginal propensity to consume What is the multiplier What would happen to equilibrium GDP if government purchases were reduced by $60 and the price level remained unchanged
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You are given the following information about an economy: img a. Find equilibrium GDP and the budget deficit. b. Suppose the government, unhappy with the budget deficit, decides to cut government spending by precisely the amount of the deficit you just found. What actually happens to GDP and the budget deficit, and why
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In a certain economy, the multiplier for government purchases is 2 and the multiplier for changes in fixed taxes is 1.5. The government then proposes to raise both spending and taxes by $100 billion. What should happen to equilibrium GDP on the demand side
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This question is a variant of the previous problem that approaches things in the way that a fiscal policy planner might. In an economy whose consumption function and tax function are as given in Test Yourself Question 1, with investment fixed at 320 and net exports fixed at -80, find the value of G that would make GDP equal to 1,800 Reference Test Yourself Question 1, Consider an economy described by the following set of equations: img Find the equilibrium level of GDP. Next, find the multipliers for government purchases and for fixed taxes. If full employment comes at Y = 1,800, what are some policies that would move GDP to that level
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Suppose you are put in charge of fiscal policy for the economy described in Test Yourself Question 1. There is an inflationary gap, and you want to reduce income by $120. What specific actions can you take to achieve this goal
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If the government decides that aggregate demand is excessive and is causing inflation, what options are open to it What if the government decides that aggregate demand is too weak instead
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(More difficult) In the economy considered in Test Yourself Question 3, suppose the government, seeing that it has not wiped out the deficit, keeps cutting G until it succeeds in balancing the budget. What level of GDP will then prevail Reference Test Yourself Question 3, You are given the following information about an economy: img a. Find equilibrium GDP and the budget deficit. b. Suppose the government, unhappy with the budget deficit, decides to cut government spending by precisely the amount of the deficit you just found. What actually happens to GDP and the budget deficit, and why
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Consider an economy described by the following set of equations: img Find the equilibrium level of GDP. Next, find the multipliers for government purchases and for fixed taxes. If full employment comes at Y = 1,800, what are some policies that would move GDP to that level
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