Economy practice

What is the purpose of expansionary fiscal policy?

To stabilize the economy by increasing spending, reducing taxes, or both, particularly during recession.

What are the two types of government spending?

Mandatory spending (automatic) and discretionary spending (requires annual review).

Give an example of mandatory spending.

Social Security, which constitutes 63% of the federal budget.

What happens to output and employment when aggregate demand falls?

They decline.

What is required for expansionary fiscal policy to correct recessionary gaps?

Increasing spending, reducing taxes, or both.

What determines the extent of spending or tax change in fiscal policy?

The marginal propensity to consume (MPC) and the multiplier.

How much must taxes be cut to achieve the same effect as a $5 billion spending increase with an MPC of 0.75?

$6.67 billion tax cut is required.

What is a budget deficit?

A situation where government spending exceeds tax revenues.

What does contractionary fiscal policy aim to reduce?

Inflationary gaps when aggregate demand rises.

What mechanisms are used in contractionary fiscal policy?

Tax increases or reduced government spending.

Why are tax changes considered less effective than spending changes in contractionary fiscal policy?

Because part of tax increases may be saved instead of spent.

What is the ratchet effect in fiscal policy?

It describes how prices do not return to previous levels due to sticky wages and prices.

What could happen if the government has a balanced budget and undertakes contractionary policy?

It could create a budget surplus where tax revenues are greater than government spending.

What are automatic stabilizers?

Government programs that automatically change spending and taxes during economic instability without new policies being passed.

Give examples of automatic stabilizers.

Transfer payments from safety net programs and progressive income taxes.

What happens to government spending during a recession with automatic stabilizers?

It automatically rises to help stabilize the economy as more households become eligible for government programs.

How do progressive income taxes work?

• They base the tax rate on household income levels, with lower incomes paying a lower percentage and higher incomes paying a larger percentage.

What is fiscal policy?

The use of government spending and taxation to influence the economy.

What is the primary goal of contractionary fiscal policy?

To decrease aggregate demand and control inflation.

What can trigger an expansionary fiscal policy?

Economic downturns or recessions.

How does government spending impact economic activity?

It increases aggregate demand, leading to higher output and employment.

What is the relationship between the marginal propensity to consume and fiscal policy?

Higher MPC means greater effectiveness of fiscal policy due to increased consumption from income changes.

Describe the role of automatic stabilizers in fiscal policy.

They help stabilize the economy by adjusting government spending and taxes based on economic conditions without new legislation.

What effect do tax cuts have on consumer spending?

They increase disposable income, which can boost consumer spending.

What is the significance of a budget surplus?

It indicates that government revenues exceed expenditures, allowing for debt reduction or increased savings.

What are the potential downsides of high levels of government debt?

It can lead to higher interest rates, reduced investment, and economic instability.

How do discretionary fiscal policies differ from mandatory fiscal policies?

Discretionary policies require annual decisions and are changeable, while mandatory policies are fixed by law.