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Macroeconomics: Fiscal Policy and Multipliers

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  • What is fiscal policy?

    Fiscal policy refers to changes in federal government purchases, transfer payments, and taxes intended to achieve macroeconomic objectives.

  • What are automatic stabilizers in fiscal policy?

    Automatic stabilizers are government spending and taxes that automatically increase or decrease with the business cycle, such as unemployment insurance payments rising during recessions.

  • What is discretionary fiscal policy?

    Discretionary fiscal policy involves intentional government actions to change spending or taxes to influence the economy.

  • How does an increase in government purchases affect aggregate demand?

    An increase in government purchases directly increases aggregate demand, shifting the aggregate demand curve to the right.

  • How do changes in taxes affect aggregate demand?

    Changes in taxes affect income, which in turn affects consumption, causing an indirect effect on aggregate demand.

  • What is expansionary fiscal policy?

    Expansionary fiscal policy involves increasing government purchases or decreasing taxes to raise real GDP and reduce unemployment.

  • What is contractionary fiscal policy?

    Contractionary fiscal policy involves decreasing government purchases or increasing taxes to reduce inflation when real GDP is above potential.

  • What is the multiplier effect in fiscal policy?

    The multiplier effect is the process where an initial change in autonomous expenditure leads to a larger change in real GDP through induced consumption.

  • How is the government purchases multiplier calculated?

    The government purchases multiplier is \(\frac{1}{1-MPC}\), where MPC is the marginal propensity to consume.

  • What is the tax multiplier and its sign?

    The tax multiplier is \(-\frac{MPC}{1-MPC}\) and is negative because an increase in taxes decreases equilibrium real GDP.

  • What is the balanced budget multiplier?

    The balanced budget multiplier states that an equal increase in government spending and taxes increases GDP by the same amount as the increase in spending.

  • How do tax rates affect the government purchases multiplier?

    Higher tax rates reduce disposable income and thus reduce the government purchases multiplier.

  • What is the effect of imports on the government purchases multiplier in an open economy?

    Imports reduce the multiplier because some spending leaks abroad; the multiplier becomes \(\frac{1}{1 - MPC(1 - t) + MPI}\), where MPI is the marginal propensity to import.

  • What are transfer payments and their multiplier effect?

    Transfer payments are government payments without goods or services in return; increases raise disposable income and consumption, causing a positive multiplier effect.

  • How does expansionary fiscal policy affect the price level in the short run?

    Expansionary fiscal policy increases aggregate demand, which raises both real GDP and the price level due to the upward-sloping short-run aggregate supply curve.

  • What is the difference between autonomous and induced increases in aggregate demand?

    Autonomous increases are initial government spending changes; induced increases are additional consumption spending triggered by increased income.

  • What happens to real GDP when government purchases increase by \$10 billion with MPC = 0.75?

    Real GDP increases by \$40 billion because the government purchases multiplier is 4 when MPC = 0.75.

  • Why is the tax multiplier smaller in absolute value than the government purchases multiplier?

    Because tax changes affect aggregate demand indirectly through disposable income, the tax multiplier is smaller in absolute value than the direct effect of government purchases.

  • What is the role of fiscal policy during a recession?

    During a recession, expansionary fiscal policy increases government purchases or cuts taxes to raise real GDP and reduce unemployment.

  • What is the role of fiscal policy during rising inflation?

    During rising inflation, contractionary fiscal policy decreases government purchases or raises taxes to lower aggregate demand and reduce inflation.