Answers to last Years Final - multiplier effect Net...

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Practice Final Exam for Economics DEFINITIONS Consumption Smoothing -The idea that consumers prefer to smooth out their consumption over time by using credit markets to borrow against future income or by saving temporary increases in their incomes. Constant Returns to Scale- Constant returns to scale imply that when the factors of productivity are increased by a scalar c , the out put Y are increased by the same scalar c. X is countercyclical- X moves in the opposite direction of GDP, if GDP goes up then x goes down and vice versa. Leading Variable- A leading variables gives a hint of how GPD is going to move in the future i.e. when a leading variable peaks it is likely that GDP is about to peak. Lump Sum Taxes- a fixed amount of taxes that do not distort the decisions of consumers by distorting prices. RICARDIAN APPROACH TO BUDGET DEFICITS In the standard model a reduction in taxes increases lifetime wealth for the consumer therefore increasing their level of consumption and implying a positive
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Unformatted text preview: multiplier effect. Net national savings decreases, the real interest rate increases, and investment goes down and in the long-run the effect is reflected in a lower stock of capital. In the Ricardian point of view a reduction in taxes does not increase the lifetime wealth of forward looking consumers who anticipate a later increase in taxes to repay the budget deficit. In this view consumers save the tax cut and use it to pay for the increased taxes in the future. Net national savings stays and the real interest rate also stays the same. RULES VERSUS DISCRETION IN MONETARY POLICY Optimal choices with commitment for the future are time inconsistent. Changing the policies as the future arrives (discretionary policies) only brings bad results for the economy. That is the reason why policies with rules are better than discretion. The way to achieve this is through Inflation Targeting and Central Bank Independence....
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