All Flashcards
How does expansionary fiscal policy apply during a recession?
It increases government spending and decreases taxes, shifting the AD curve to the right, increasing output and reducing unemployment.
How does contractionary fiscal policy apply during inflation?
It decreases government spending and increases taxes, shifting the AD curve to the left, decreasing price levels.
How do automatic stabilizers work during a recession?
Unemployment benefits increase, providing income to those who lost jobs, thus maintaining some level of aggregate demand.
How does increased government spending impact Aggregate Demand?
Increased government spending directly increases aggregate demand, shifting the AD curve to the right.
How do tax cuts affect disposable income and consumer spending?
Tax cuts increase disposable income, leading to increased consumer spending, which shifts the AD curve to the right.
How does fiscal policy address a recessionary gap?
Expansionary fiscal policy shifts the AD curve to the right, increasing output and employment to close the gap.
How does fiscal policy address an inflationary gap?
Contractionary fiscal policy shifts the AD curve to the left, decreasing price levels to close the gap.
If MPC is 0.75, how much does the economy grow for every $1 increase in government spending?
The spending multiplier is 1/(1-0.75) = 4. So, the economy grows by $4.
If MPC is 0.6, how much does the economy change for every $1 decrease in taxes?
The tax multiplier is 0.6/(1-0.6) = 1.5. So, the economy grows by $1.5.
How does government spending compare to tax cuts in stimulating the economy?
Government spending is more effective because it directly increases aggregate demand, while tax cuts may lead to some savings.
What is Fiscal Policy?
Government management of the economy through government spending and taxation.
What is Expansionary Fiscal Policy?
Increasing government spending or decreasing taxes to boost the economy during a recession.
What is Contractionary Fiscal Policy?
Decreasing government spending or increasing taxes to cool down the economy during inflation.
What is Discretionary Fiscal Policy?
Deliberate actions by Congress to change AD through new spending or tax laws.
What is Non-Discretionary Fiscal Policy?
Automatic stabilizers already in place, like social security and unemployment benefits.
What is a Recessionary Gap?
Economy producing less than its potential; high unemployment, low output.
What is an Inflationary Gap?
Economy producing more than its potential; high inflation, potential overheating.
What is the Spending Multiplier?
How much total spending increases for each dollar of government spending. Formula: 1/MPS
What is the Tax Multiplier?
How much total spending changes for each dollar change in taxes. Formula: MPC/MPS
What is Marginal Propensity to Consume (MPC)?
The proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it.
What are the differences between discretionary and non-discretionary fiscal policy?
Discretionary is deliberate, requiring congressional action. Non-discretionary is automatic, like unemployment benefits.
What are the differences between expansionary and contractionary fiscal policy?
Expansionary boosts the economy (increase G, decrease T). Contractionary cools it down (decrease G, increase T).
What are the differences between the spending multiplier and the tax multiplier?
Spending multiplier is 1/MPS, while the tax multiplier is MPC/MPS. The spending multiplier is larger.
What are the differences between fiscal policy and monetary policy?
Fiscal policy uses government spending and taxation; monetary policy uses interest rates and the money supply.
What are the differences between a recessionary gap and an inflationary gap?
Recessionary gap: output below potential. Inflationary gap: output above potential.
Compare and contrast the effects of increasing government spending versus decreasing taxes.
Both increase AD, but government spending has a more direct and larger impact due to the spending multiplier.
Compare and contrast the effects of increasing taxes versus decreasing government spending.
Both decrease AD, but increasing taxes directly reduces disposable income, while decreasing government spending directly reduces government purchases.
What are the key differences between the short-run and long-run effects of fiscal policy?
In the short run, fiscal policy affects output and prices. In the long run, it can affect potential output and debt levels.
How does the effectiveness of fiscal policy differ in a closed vs. an open economy?
In an open economy, fiscal policy can be affected by exchange rates and international trade flows.
Compare the advantages and disadvantages of discretionary vs. automatic fiscal policy.
Discretionary policy can be tailored but suffers from lags; automatic policy is timely but less precise.