Economic test next week

What is expansionary fiscal policy?

Uses discretionary government spending or taxes to stabilize the economy.

What are the two types of government spending?

Mandatory spending and discretionary spending.

What is mandatory spending?

Automatic and written into law, e.g., Social Security; accounts for 63% of the federal budget.

What is discretionary spending?

Requires annual review, e.g., Transportation, Education, Science.

How does expansionary fiscal policy impact aggregate demand?

Increases spending or reduces taxes to correct recessionary gaps.

What is an example of expansionary fiscal policy addressing a recessionary gap?

Government spending rises, moving aggregate demand from AD1 to AD2, leading to a $20 billion recessionary gap.

If the MPC is 0.75, how much of a tax cut is needed to match a $5 billion spending increase?

A tax cut of $6.67 billion is needed.

What happens to budget deficits and national debt as spending exceeds tax revenues?

Budget deficits are created and financed through government securities, increasing national debt.

What is the purpose of contractionary fiscal policy?

Reduces inflationary gaps when aggregate demand rises.

What mechanisms are involved in contractionary fiscal policy?

Involves tax increases and reduced government spending.

What effect should be considered when implementing contractionary fiscal policy?

The ratchet effect; prices may not return to previous levels.

If the MPC is 0.75, how much must taxes increase to reduce consumption by $3 billion?

Taxes must increase by $4 billion.

What can the multiplier effect lead to in terms of GDP reduction during contractionary fiscal policy?

A total reduction of $12 billion in GDP.

What can create a budget surplus?

When tax revenues exceed spending, especially if the government starts with a balanced budget.

What is the outcome of a budget surplus?

It can reduce national debt.

What do conservatives believe regarding government fiscal policy?

Prefer a smaller government role; favor tax cuts in recessions and spending cuts in inflation.

What do liberals believe regarding government fiscal policy?

Prefer a larger government role; support spending increases in recessions and tax increases in inflation.

What are automatic stabilizers?

Programs that automatically adjust spending or taxes during economic instability.

What is an example of an automatic stabilizer?

Transfer payments increase during recessions as unemployment rises.

How do progressive income taxes act as an automatic stabilizer?

Higher earners pay a larger percentage, benefiting tax revenue during economic growth.

What tends to happen to balanced budgets during recessions?

They tend to go into deficit.

What happens to balanced budgets during periods of economic growth?

They tend to go into surplus.

Are automatic stabilizers sufficient to manage significant demand swings?

No, they often necessitate active government intervention.

What is a recessionary gap?

A situation where aggregate demand is insufficient to support full employment.

What happens when spending exceeds tax revenue?

It creates a budget deficit.

What role does the government play in expansionary fiscal policy?

The government increases spending or reduces taxes to stimulate the economy.

What can trigger the need for contractionary fiscal policy?

A significant rise in aggregate demand that leads to inflationary gaps.

What is the ratchet effect in economics?

The phenomenon where prices do not fall back after rising during inflation.

In terms of fiscal policy, what do ‘mandatory expenditures’ indicate?

Obligations that must be paid in the budget, like Social Security.

What percentage of the federal budget is accounted for by mandatory spending?

63%.

What is the impact of discretionary spending on the economy?

It requires annual review and can be adjusted to respond to economic conditions.

How do tax policies affect consumers during recession?

Lower taxes may increase disposable income, stimulating spending.

What fiscal tools can the government utilize in response to a recession?

Increase government spending or decrease taxes.

Can a budget deficit lead to positive fiscal outcomes?

Yes, if it stimulates economic growth, resulting in higher future revenues.

What determines the effectiveness of automatic stabilizers?

Their ability to respond quickly to changes in the economic environment.

Why might automatic stabilizers not be enough to stabilize significant economic swings?

They may not adjust sufficiently or quickly without additional government action.

What fiscal policies do liberals typically advocate during inflation?

Support for tax increases to help reduce spending.

What is an economic consequence of increased national debt?

Potential future tax increases or reduced government spending.

What is the basic principle behind fiscal policy?

To use government spending and tax policies to influence economic activity.

Why is understanding the government’s stance on fiscal policy important?

It helps predict the economic environment and government actions regarding taxation and spending.