macsg09 - 9 [24] The Government and Fiscal Policy C hapter...

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223 9 [24] The Government and Fiscal Policy C hapter objectives: 1. Identify the tools of fiscal policy. 2. Describe how the inclusion of the government sector affects the aggregate expenditure model. 3. Derive and explain the difference between the government spending multiplier and the tax multiplier. Explain how the balanced-budget multiplier result occurs. 4. Analyze the effects on output and unemployment of a change in government spending and/or a change in taxes. 5. Define the deficit (surplus) and explain how it relates to and differs from the federal debt. Describe how the federal government’s expenditures and revenues move with the economy. Distinguish between and explain the effects of fiscal drag and automatic stabilizers. 6. Define the full-employment budget, the structural deficit, and the cyclical deficit. 7. Explain how the incorporation of tax rates will influence the spending multiplier. The basic logic in this chapter is the same as in Chapter 8 (23). Even the Appendices contain little that is very new. If you’re confused in this chapter, it’s a sure sign that you need to go back now and work on Chapter 8 (23) some more. BRAIN TEASER: In our current model, we assume that net taxes are lump-sum, that is, that they don’t change as the level of economic activity changes. However, automatic stabilizers (such as the federal income tax system) do, in fact, change with the level of economic activity. How do automatic stabilizers affect the size of the expenditure multiplier and why? OBJECTIVE 1: Identify the tools of fiscal policy. Fiscal policy has three basic tools: government purchases ( G ), taxation, and transfer payments. To simplify matters, our model uses lump-sum taxes (which are not related to income). Collectively, taxes and transfers are termed net taxes ( T ). For simplification, the text (except in Appendix 9B (24B)) assumes that net taxes are unrelated to income. (page 159 [471])
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224 Study Guide to Principles of Macroeconomics Practice 1. Each of the following might be a specific fiscal policy action EXCEPT (a) reducing interest rates to stimulate consumer demand. (b) increasing government spending on military hardware. (c) easing the eligibility requirements for welfare recipients. (d) imposing a national sales tax. ANSWER: (a) Interest rate changes come under the category of monetary policy.   OBJECTIVE 2: Describe how the inclusion of the government sector affects the aggregate expenditure model. When the government sector is added to the aggregate expenditure model, government spending is included in aggregate expenditure alongside consumption and investment. Consumption and saving are based on disposable (after-tax) personal income and the equilibrium condition is: Y = C + I + G or S + T = I + G (page 161 [473]) Increasing government spending or reducing net taxes increases aggregate expenditure and the equilibrium level of production. Note:
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This note was uploaded on 02/13/2010 for the course ECON 1102 taught by Professor Wissink during the Spring '09 term at Cornell University (Engineering School).

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macsg09 - 9 [24] The Government and Fiscal Policy C hapter...

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