2. Fiscal Policy “G” & “T” Striking Out A Recession John Maynard Keynes “Father of Fiscal Policy”

3. FISCAL POLICY Even if I have to dig a hole and cover it back up, I do have a job.

4. Introduction This chapter confronts the following questions: government spending and tax policies 1. Can government spending and tax policies help ensure full employment? 2. What policy actions will fight inflation help fight inflation? roles of government intervention 3. What are the roles of government intervention?

5. T axes (“T”) and “G” Spending T axes (“T”) and “G” Spending Up until 1915, the federal government collected few taxes and spent little. 1902In 1902, it employed fewer than 350,000 people and spent $650 million. Today, it employs nearly 5 million people and spends more than $2.5 trillion.

6. Government Revenue Government expansion started with the 16th Amendment to the U.S. Constitution (1913) which extended the taxing power to incomes. Today, the federal government collects over $2 trillion a year in tax revenues.

7. Real Interest Rate, (percent) Quantity of Loanable Funds Loanable Funds Market [*Use this graph if there is a chg in savings by consumers or chg in fiscal policy] [* Use the Money Market graph when there is a change in MS ] IR=8%IR=8%IR=8%IR=8% D1D1D1D1 F1F1F1F1 S balanced budget Starting from a balanced budget, if the G incr spendingdecr T G incr spending or decr T to get out of recession a recession, they would now be running deficitpushing a deficit and have to borrow, pushing up demand in the LFMincreasing up demand in the LFM and increasing the interest rate the interest rate. D2D2D2D2 I R = 10 % F2F2F2F2 E1E1E1E1 E2E2E2E2 “real interest rate” Use the “real interest rate” with LFMlong-term LFM, because it is long-term. “nominal interest rate” Use “nominal interest rate” with money marketshort-term money market, as it is short-term. Borrowers Lenders

8. Demand for Loanable Funds Market (a) (b) Demand for L oanable Funds at 3 % [no G borrowing] Business firms demand for L oanable Funds at 3 % [a lot of investment] Rate Interest 3% 3% S D 1[ no G] LFM A A Trillions of Dollars 3% 1.5 QID QID DIDIDIDI Low interest rates, so - a lot of investment Real

9. Demand for Loanable Funds Market (a) (b) Rate Interest 3% 3% S D 1[ no G] LFM A Trillions of Dollars 3% 1.5 QID 1 QID 1 DIDIDIDI With “G” borrowing, the demand for LF at 5 % Business firms d emand for Loanable Funds at 5 % [not as much investment] D 2 (G) 5% B QID2 QID1 Higher interest rates, so not as much investment 5% 1.0 Government Demand for Funds Business Demand for Funds A B Real

10. B alanced B udget [$2 T ril. “G” = $2 T ril. “T”] $2 Trillion G T Recession Incr G to $2.2 or or Decr T to $1.8 Deficit so higher I.R. Inflation Decr G to $1.8 or Incr T to $2.2 Surplus so Lower I.R. Budget So expansionary fiscal policy leads to higher interest rates. Deficit Wow! A surplus So, contractionary fiscal policy leads to lower interest rates. Gonna have to borrow

11. Real GDP Q PL SRAS AD 2 YRYRYRYR YFYFYFYF Expansionary Fiscal Policy [Incr G; Decr T] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DIDIDIDICAD Y/Emp/PL; TLFM IRIRIRIR Start from a Balanced Budget G & T = $2 Trillion $ 2 T $2 T “I can’t get a job.” “N ow, this is better.” G T G T E1E1E1E1 E2E2E2E2 LRAS

12. Real GDP Q PL AS AD 2 YIYIYIYI YFYFYFYF Contractionary Fiscal Policy [Decr G; Incr T to close a contractionary gap ] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DIDIDIDICAD Y/Emp/PL; TLFMIR Start from a Balanced Budget G & T = $2 Trillion $2T $2T G T G T [like we have “money trees”] E1E1E1E1 E2E2E2E2

13. Everyone Wants To Go To Heaven But No One Wants To Die. Everyone Wants Government Spending But No One Wants To Pay Taxes.

14. Expansionary Fiscal Policy Recessionary Gap T G Fiscal Policy During Recession SRAS AD2 AD2 Y R Y * AD1 Keynes and Lydia Lopokova

15. Expansionary Fiscal Policy Inflationary Gap T G Fiscal Policy During Inflation SRAS AD2 AD2 Y* YIY* YIY* YIY* YI AD1 Contractionary Fiscal Policy G T

16. Nondiscretionary Fiscal Policy (Automatic stabilizers) Transfer Payments 1. Transfer Payments A. Welfare checks B. U nemployment checks C. Food Stamps D. Social Security E. C orporate dividends F. Veteran’s benefits Progressive Income Taxes 2. Progressive Income Taxes Automatic Stabilizers automatic pilot The automatic stabilizers may be called the automatic pilot of our economy of our economy, not very well suited for takeoffs and landings, going gets but fine for the smooth part of the flight. But when the going gets roughmust use manual controlsdiscretionary G&T rough, the economy must use manual controls. [discretionary G&T] Automatic stabilizers take 33-50% out. S tabilizers are like a thermostat maintaining temperature. Y R ; T ; AD 2 Y I ; T ; AD 3 AD 2 AD 3 Y R Y* Y I Y R Y* Y I AS 33 % -50 % pilot may take a stroll thruco-pilot cruise A pilot may take a stroll thru & let the co-pilot cruise. If there is turbulencepilot will rush back to the cockpit turbulence, the pilot will rush back to the cockpit use manual [President & Congress] and use manual controls to correct economic turbulenceDiscretionary controls to correct economic turbulence. Discretionary fiscal policy is our manual control system fiscal policy is our manual control system.

17. BUILT-IN STABILITY GDP 1 GDP 2 GDP 3 Real Domestic Output, GDP Government Expenditures, G, and Tax Revenues, T Deficit Surplus Taxes G YRYRYRYRY* YiYiYiYi More vertical [more progressive], the more stability for the economy. Transfers Surplus FewerTransfers MoreTransfers Less Tax Money

18. Keynesian Model Recess. Gap Inflat. Gap

19. Discretionary Fiscal Policy Deliberate use of government spending and/or taxing. “G” and “T” Nondiscretionary Fiscal Policy Automatic Stabilizers 1.Welfare & food stamps 2. Unemploy. insurance 3. Social security 4. Corporate Dividends Progressive Tax System 5. Progressive Tax System Unempl. check Discretion of Congress

20. Suppose the economy is in recession : Real GDP Taxcollections Transfer payments GT G > T The deficit grows Fiscal Policy Automatic stabilizers. AS AD 2 AD 1 “Recession” Y R Y* PL

21. If the economy has an inflationary gap: Taxcollections Transfer payments G TG < TG TG < T The surplus grows Fiscal Policy Automatic stabilizers. Real GDP AS “Inflationary Gap” AD 2 AD 1 Y* Y I PL

22. Discretionary Fiscal Policy Discretionary Contractionary Fiscal Policy 1.Decrease “G” 2.Increase “T” Expansionary Fis. Policy 1.Increase “G” 2.Decrease “T”

23. The Kennedy/Johnson $10 Bil. Tax Cuts of 1964 The “Golden Age of Fiscal Policy”

24. When Kennedy came into office: 91 % 1.T he top marginal tax rate was 91 % drops to 52% and drops to 52% compared 35% to 35% today. 6.7 % 2. T he unemployment rate was 6.7 % below 5% and drops below 5%. recession low unemployment-low inflation (2%) economy 3. A recession becomes a very good low unemployment-low inflation (2%) economy expansion 4. The expansion continued to 1969. Fiscal Policy and Tax Cuts Fiscal Policy and Tax Cuts.

25. BUILT-IN STABILITY Tax Progressivity high income groupsProgressive Tax System– takes more from high income groups takes same from all income groupsProportional Tax System – flat rate tax takes same from all income groups low income groupsRegressive Tax System – takes more from low income groups The more progressive the tax system, the greater the economy’s built-in stability

26. Keynesian Policy: “ Balance the Economy, not the Budget.” DeficitsSurpluses “ Even if the jobs are digging holes and filling them up.”

27. 2. Just print the money [Money creation – lower interest rates [Money creation – lower interest rates so this would be more expansionary] so this would be more expansionary] FINANCING OF DEFICITS [Should we borrow or just print the money?] 1. Borrowing from the public [results in higher interest rates which crowds out investment] which crowds out investment] 7%4% MS1 MS2 AS AD 2 Y * Y Y * Y But the LR increase in MS results in an increase in inflation PL 1 PL 2 AD 1 Lower I.R. HigherI.R.

28. How To Dispose of Surpluses [Should we hold the surplus or give it back] 1. Debt Retirement [Give the surplus back during recessions to get lower interest rates and expand the economy] AS AD 2 Y* Y I 2. Impound The Surplus [Keep the surplus during inflations and give it back during recessions] PL AD 1

29. DIDIDIDI Investment (billions of dollars) Real interest rate (%) THE “CROWDING OUT” EFFECT [Incr G incr I.R. Decr Ig] 16 14 12 10 8 6 4 2 0 15 5 10 15 20 25 30 35 40 CrowdingOutEffect AS AD 1 AD2 4%4%2%2%4%4%2%2% YRYRYRYR G IGIGIGIG G can finance a deficit by: 1. Borrowing - this raises interest rates in the LFM and “crowds out” investment. the LFM and “crowds out” investment. 2. Money Creation - no “crowding out” so is more expansionary than borrowing. more expansionary than borrowing. Friedman Just follow the “monetary rule.” Y*Y*Y*Y*

30. Y R Y * Y* Y i Negative Net Export Effect of Fiscal Policy Y R Y* Due to lower interest rates, dollar deprec. E xpansionary Fiscal Policy “Negative Xn” C ontractionary Fiscal Policy Due to higher interest rates, dollar apprec.

31. Liberal (“ G ”) or Conservative (“G”) Liberals Recession: Increase “G”; Inflation: Increase T “ G G Conservatives Recession: Decrease “T”; Inflation: Decrease “G”

32. Fiscal Policy Lags starts out too cold “The shower starts out too cold, because the pipes have turns up the hot water not yet warmed up. So the fool turns up the hot water. turns up the hot water further nothing happens, so he turns up the hot water further. scalds himturns up the The hot water comes on and scalds him. He turns up the cold waterturns up cold water. Nothing happens right away, so he turns up the cold further the cold further. When the cold finally starts to come up, too cold he finds the shower too cold, and so it goes.” Fiscal Policy lags 1.Data (recognition) lag 2.“Wait-and-see” lag – short run 3.Legislative lag (political) 4.Effect lag [takes months]

33. The G is like a “ Fool in the Shower.” YFYFYFYF YRYRYRYR YIYIYIYI AD 2 AD 1 LRAS LRAS SRAS 1 SRAS 2 E4E4E4E4 E4E4E4E4 E2E2E2E2 E1E1E1E1 E2E2E2E2 E3E3E3E3

34. Traditional Fiscal Policy [“G” & “T”] will not work with Stagflation AD 1 LRAS 4% 5%5%5%5% 10 % 10 % 10 % Y R SRAS 2 Stagflation AD 2 15% 15 % AD3 YFYFYFYF YRYRYRYR

35. Laffer Curve and Supply-Side Economics “closet Keynesian” Was Reagan a “closet Keynesian” with all the “G” & “T”? “Keynesian in drag.” Perhaps he was a “Keynesian in drag.”

36. 0 100 l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

37. 0 100 m l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

38. 0 100 m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent)

39. 0 100 m m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent) Maximum Tax Revenue

40. 0 100 m m n l THE LAFFER CURVE Tax revenue (dollars) Tax rate (percent) Maximum Tax Revenue President Reagan said he was on the Laffer curve. He said that after WW II, when he started making big money, that he could do 4 movies before hitting the top marginal tax rate of 90%. After 4, because he could only keep 10%, he would quit making movies until the next year. “Yes, I was on the Laffer cuve. I couldn’t shoot my way out” The “Gipper” Bonzo rich peopledisincentive to quitworking For rich people, there would be a disincentive to quit working when most workersnot the case they hit the top marginal tax rate. For most workers, this was not the case. R eagan

41. SUPPLY-SIDE FISCAL POLICY Emphasis on Expansionary Tax Cuts [ which shifts AD to the right, increasing Y & PL] Impact upon... Saving and InvestmentSaving and Investment [Lower taxes increase DI & S; less business taxes will increase investment. Our “national factory” will increase.] Work Incentives [Keeping more of our money makes us work harder and longer] Risk Taking [Lower tax rates promise a larger potential after-tax reward] AS Curve will shift right bringing prices down. So, the AS Curve will shift right bringing prices down.

42. SUPPLY-SIDE FISCAL POLICY 0 Price level Real domestic output, GDP AD 1 AD 2 AS 1 AS 2 P1P1 P2P2 P3P3 Q1Q1Q1Q1 Q2Q2Q2Q2 Q3Q3Q3Q3 Can sustain a much greater increase in AD if the AS curve is also shifting to the right.

43. Price Level AS AD 2 Inflation and the Multiplier [4] GDP 1 GDP 2 MULTIPLIER WITH PRICE-LEVEL CHANGES P1P1 AD 1 AD 3 GDP 3 P2P2 Full Multiplier Effect ReducedMultiplier Effect Due to Inflation +20 + 80 bil. +20 + 40 bil. M(4)=chg.Y/chg.E [80] [20] [80] [20] M(2)=chg.Y/chg. E [40] [20] [40] [20]

44. Price level Real GDP (billions) EXPANSIONARY FISCAL POLICY Full $20 billion increase in AD AD 2 AD 1 $5 billion initial direct increase in spending MPS=.25 [MPS=.25] the multiplier at work... P1P1 $485 $505

45. Price level Real GDP (billions) CONTRACTIONARY FISCAL POLICY MPS=.25 [MPS=.25] the multiplier at work... P3P3 $515 Full $20 billion decrease in AD AD 4 AD 3 $5 billion initial direct decrease in spending P4P4

46. LEGISLATIVE MANDATES Employment Act of 1946 C ouncil of E conomic A dvisors (CEA) J oint E conomic C ommittee (JEC)

47. Legislative Mandates for Remedial Fiscal Measures Employment Act of 1946 1. Employment Act of 1946 – a law promoting economic stability “maximum employment, production, and (by promoting “maximum employment, production, and purchasing power”monetary and fiscal policies purchasing power”) through monetary and fiscal policies. government commitment This act was a government commitment to ensure prosperity “could”“would” after WWII. [ not only “could” but “would” – no more laissez faire] Keynesians economists This act gave the Keynesians economists the theoretical and legal justificationuse fiscal policy legal justification to use fiscal policy to stabilize the economy. Council of Economic Advisers (CEA) 2. Council of Economic Advisers (CEA) President3 distinguished economists [for the President] – 3 distinguished economists ( on leave from assist & advise the President universities) who assist & advise the President on economic matters. Their staff is made up of 11 senior and 6 junior economists. deficit, inflation, GDP growth, They forecast & project the deficit, inflation, GDP growth, foreign exchange rates, immigration, & antitrust legislation foreign exchange rates, immigration, & antitrust legislation. The President must submit an annual economic report describing the current economic state with recommendations. “T he President’s intelligence arm in the war against the business cycle.”

48. Head of the CEA Greg Mankiw of Harvard has ridiculed supply-side tax cuts as “fad economics” conceived by “ charlatans and cranks,” in his textbook. Harvey S. Rosen of Princeton succeeded Mankiw. Ben Bernanke, F ormer B oard G overnor, succeeded Rosen. [scored 1590 on SAT]

49. Joint Economic Committee of Congress and Humphrey-Hawkins Act of 1978 If you look at my “C” average college grades, the CEA can help me.

50. President Bush’s College Transcript

51. President Bush’s College Transcript – Cumulative 77 Ave. “So - - If you are having a hard time in Economics, don’t worry about it. You can always be President of the United States.” John Kerry had only a 76 cumulative average, including 4 Ds as a freshman in geology(61), American History(63 & 68), & government(69). His highest grade was 89.

52. Keynesians Return To Washington [1993] Nobel Prize in Economics-2001

53. ADDING THE PUBLIC SECTOR[“ ”] Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 390 470 550 C C + I g + X n C + I g + X n + G Government Spending of $20 Billion $20 Billion Government Purchases and Equilibrium GDP S Mixed - open $ 20 bil. for Nat. Defense “M” = 4

54. $15 B decrease in “C” [ & $60 B total decrease in Y from a $20 billion in Y from a $20 billion increase in taxes increase in taxes ADDING THE PUBLIC SECTOR[“ ”] Incr. T by $20 bil.[MT = 3] Equilibrium GDP[-60] Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 550 C + I g + X n + G C a + I g + X n + G 490 S Mixed-Open $20 bil. increase in “T”

55. Balanced Budget Multiplier [$20 billion] [“T” affects AD indirectly thru “C”; “G” affects AD directly] GDP = $80 Net Change in GDP = The increase in “T” means we would have consumed $15 and kept $5 in our pockets. The increase in “G” flows directly into the economy. M E = 1/MPS M E = 1/.25 = 4 So, 4 x $20 = $80 G $20 MT = MPC/MPS=.75/.25= 3 So, 3 x -$20 = -$60 GDP = -$60 Ca= -$15 Sa= -$5 T $20 $470 billion AS AD1 $490 billion PL AD 2 +$20

56. Employment Act of 1946 1. With the Employment Act of 1946, the federal government committed itself to accept (total/some) degree of responsibility for employment/prices. Fiscal policy 2. Fiscal policy is carried out primarily by the (local/state/federal ) government. Discretionary fiscal policy 3. Discretionary fiscal policy [G & T] (does/does not) require congressional action. mixedclosed economy 4. In a mixed [private & public) closed economy, taxes & (savings/government spending) leakages injections are leakages, while Ig and (savings/government spending) are injections. 5. In a mixed economy, the equilibrium GDP exists where (C+Ig/C+Ig+G+Xn) = GDP. balanced budget multiplier 6. The balanced budget multiplier indicates that equal increases in G&T tend to (decrease/increase/not change) the equilibrium GDP. [M BB is “1”] equilibrium GDP is $400 billion 7. Assume in a private economy that equilibrium GDP is $400 billion & the MPC is G collects new taxes of $50 bil.spends the entire amount.80. Suppose the G collects new taxes of $50 bil. & spends the entire amount on our infrastructure. As a result equilibrium GDP will be ($400/$450/$500) bil. constitutional amendmentG always balance 8. Suppose a constitutional amendment requires that the G always balance its budgetincrease GDP by $40 billion its budget. If it desired to increase GDP by $40 billion, G should (increase/decrease) government spending & taxes by ($30/$40/$50) billion. Fiscal Policy NS 1-8

57. F.E. GDP is OC 12. If the F.E. GDP is OC, then it would be appropriate fiscal policy for “G”“T” government to (increase/decrease) “G” and (increase/decrease) “T”. F.E. GDP is OA 13. If the F.E. GDP is OA, then it would be appropriate fiscal policy for “G”“T” government to (increase/decrease) “G” and (increase/decrease) “T”. eliminate a budget deficit during a depression 10. If the government tries to eliminate a budget deficit during a depression, these efforts will (help/hurt) the depression. conservative economist 11. A conservative economist who advocates an active fiscal policy taxrecession would recommend tax (increases/decreases) during a recession and government spendinginflation (increases/decreases) in government spending during inflation. severe recession 9. In a severe recession, Keynesians would favor a(n) (increase/decrease) in taxes.Y CA AE 1 AE 2 PL Y R Y* Y R Y* 800 ? AE PL O

58. during a recession 14. If G increases its spending during a recession to assist the economy, the funds must come from some source. (Additional taxes/Borrowing from the public/Creating new money) most expansionary would tend to be the most expansionary. fiscal actions 15. The following fiscal actions, ( incurring a budget surplus and allowing it to accumulate as idle Treasury balances/ incurring a budget surplus which is used to retire debt held curbing inflation by the public) is likely to be most effective in curbing inflation. greatest anti-inflationary impact of a budget 16. The greatest anti-inflationary impact of a budget surplus surplus will occur when the G (impounds/uses) the surplus funds & lets them (stand idle/pay off the debt). built-in stabilizers 17. In describing the built-in stabilizers, we can say that personal & corporate income tax collections as GDP increasestransfers automatically (incr/decr) as GDP increases and transfers & subsidiesas GDP increases & subsidies (incr/decr) as GDP increases. Should I give it back?

59. Recognition, Action, & Effect Lags of Fiscal Policy Action Lag

60. Political Business Cycles? Political Business Cycles:Politicians manipulate fiscal policy to get voter support.No politician wants to go into the next election known as the “tax-raising, project-cancelling boom killer.” These policies can lead to “Made in Washington” recessions after the election to slow down the inflationary economy. The economy can be corrected prior to the next election. “The economy is largely a toy to be pulled this way and that for political purposes.” 0 Y P Real GDP Presidential Elections and U.S. Recessions, 1948-2002 Election Winner Next Recession Election winner Next Recession Nov, 48 Truman Nov. 48-Oct. 49 Nov. 72 Nixon Dec. 73-Mar. 75 Nov. 52 Ike June, 53-May 45 Nov. 76 Carter Jan. 80-July 80 Nov. 56 Ike June, 57-Apr. 58 Nov. 80 Reagan May 81-Nov. 82 Nov. 60 Kennedy Apr. 60-Feb. 61 Nov. 84 Reagan Incr bor. by $2 tr. Nov. 64 Johnson Viet Nam War Nov. 88 Bush 41 July 90-Mar. 91 Nov. 68 Nixon Oct. 69-Nov. 70 Nov. 92 Clinton None Nov. 01 Bush 43 Jan. 01-Sept. 01 “Voters tend to remember the last one or two years prior to an election.” *Tell them what they want to hear.

61. FISCAL POLICY – Pure and Simple Fiscal Policy: No Complications Price level Real GDP (billions) AD 1 AD 2 P1P1 $490 YR YR AS “diminish AD.” There are 2 things that could “diminish AD.” $510Y*

62. Fiscal Policy: Showing Crowding-out Effect or Net Export Effect Price level Real GDP (billions) AD 1 AD 2 P1P1 $490$510 $490 $510 AS AD’ 2 $504 “diminish AD.” There are 2 things that could “diminish AD.” [Crowding-out and net export effect]

63. FISCAL POLICY AND INFLATION Price level Real GDP (billions ) AS AD 2 $ 495$515 P1P1 AD 1 $505

64. Answer the next 3 questions(18-21) based on the diagram. Deficits 18. Deficits will be realized at GDP levels (below/above) C, and surpluses (below/above) C. D 19. If the F.E. GDP for the economy is at D, the F.E. budget will entail a (deficit/surplus). tax line had a greater slope 20. If the tax line had a greater slope [more progressive tax system], stability stability would be (less/greater). adhered strictly to an annually balanced budget 21. If government adhered strictly to an annually balanced budget then the government’s budget would tend to (destabilize/stabilize) the economy. T2T2 NS 18-21 1

65. NS 22-30 For Questions 22-24 22. (T1/T4) tax system is characterized least built-in stability by the least built-in stability. 23. (T1/T4) tax system is characterized by the most built-in stability. 24. (T1/T4) tax system will generate the largest cyclical deficits largest cyclical deficits. Nondiscretionary 25. Nondiscretionary Fiscal Policy (does/does not) require congressional action. $10 B increase in “G”increase “C” 26. If the MPC is.5, a $10 B increase in “G” will increase “C” not income [not income] by ($20/$10/$5) billion. [G increase in spending of $10 B increases income (Y) by $20 B. With MPC of.5, C increases $10 B] 27. If government tries to give back a surplus during an inflationary FE year, this will be (pro-cyclical/counter-cyclical). improvement 28. When politicians use fiscal policy to cause an improvement in the economy just prior to an election in the economy just prior to an election, this is called a (presidential/Congressional/political) business cycle. G incurs a deficit which is financed by borrowing 29. When G incurs a deficit which is financed by borrowing, interest rates to increase which decreases Ig causing interest rates to increase which decreases Ig, this is called the (crowding-in/crowding out) effect. Supply-sidersprimary effect of tax cuts 30. Supply-siders argue that the primary effect of tax cuts is to shift the AS curve (leftward/rightward).

66. MPS is.2 34. If the MPS is.2 and the economy has a recessionary spending gap of $5 billionequilibrium billion, we may conclude that the equilibrium level level of GDP is ($5/$20/$25) below the FE GDP. MPS is.2 33. In a private-closed economy, the MPS is.2, consumption equals income at $200 billioninvestment is $10 billion, and the level of investment is $10 billion billion. The equilibrium level of income at the new level is ($200/$250) billion. MPC is.8$2 billion increase in “G” 31. If the MPC is.8, a $2 billion increase in “G” will increase “consumption” “consumption” by ($10/$8/$6) billion. [When G increases by $2 billion, Y does increase by $10, but *8 (80%) is consumed, or $8 billion] MPC is.9$1 billion increase in “G” 32. If the MPC is.9, a $1 billion increase in “G” will increase “consumption” by ($10/$9/$8) billion. NS 31-34 C+Ig 200 200 ? “C” +$10 Ig AE AE1 AE2 Y R ? AE +$5

67. NS 35 - 38 -$6 AE1 AE2 Y* Y I MPS is.5 35. If the MPS is.5 and the economy has an inflationaryspending gap of $6 billion inflationary spending gap of $6 billion, equilibrium level we may conclude that the equilibrium level of GDP of GDP is ($6/$12/$18) billion above the FE GDP. AE government decreases G&T by $10 billion 36. If the government decreases G&T by $10 billion, then a MPS of.10 equilibrium GDP MPS of.10, the equilibrium GDP would (increase/decrease) by ($5/$10/$100) billion. MPC of.75Government increases G&T by $8 billion 37. With a MPC of.75, Government increases G&T by $8 billion. equilibrium GDP The equilibrium GDP (increases/decreases) by ($75/$32/$8) billion. government runs a budget surplus and desires to 38. If the government runs a budget surplus and desires to curb inflation curb inflation, it should (give the surplus back/keep it in storage).

68. Expansionary fiscal policy 1. Expansionary fiscal policy will be most effective [increase GDP] when the AS curve is (vertical/horizontal) & (incr/decr) “C” and (incr/decr) unemployment. paradox of thrift 2. The paradox of thrift indicates that an increase in saving (matched/ unmatched) by an increase in investment will lower equilibrium GDP. contractionary fiscal policydecr G, incr T 3. A contractionary fiscal policy [decr G, incr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. expansionary fiscal policyincr G, decr T An expansionary fiscal policy [incr G, decr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. AE[AD]doesn’t buy up FE output(GDP) 4. In the AE model, if AE[AD]doesn’t buy up FE output(GDP), then the equilibrium output is (less than/more then) full employment output. Fiscal Policy Test Review 1-4 [G ; LFM ; In. Rates ] G $2 Tr. T $2 Tr. [On #3, start from a balanced budget] “Recessionary Gap” “Inflationary Gap”

69. decrease AD the greatest amount 5. To decrease AD the greatest amount, the government should: (decrease “G” only/increase “T” only/both decr G & incr T) 6. To increase AD the greatest amount, the “G” should: (increase “G” only/ increase “T” only/both incr G and decr T) recessionary gap equilibrium point[actual GDP] 7. In a recessionary gap (AE model) at the equilibrium point[actual GDP] planned investmentsaving,FE planned investment is (greater than/equal to/less than) saving, but at the FE GDP levelsaving GDP level, planned investment [backup ] is (greater than/equal to/less than ) saving. inflationarygap 8. In an inflationary gap(AE model), at the equilibrium point [actual GDP] planned investment [backup] is (greater than/equal to/less than) saving, but at the FE level, planned investment is (greater than/equal to/less than) saving. unplanned increase in inventories 9. If businesses are experiencing an unplanned increase in inventories, AE is FE output & spending (less than/greater than) FE output & spending will (increase/decrease). unplanned decrease in inventoresdisinvestment 10. If businesses are experiencing an unplanned decrease in inventores [disinvestment] FE output & spending AE is (less than/greater than) FE output & spending will (increase/decrease)

70. “C” equals income at $500 billionMPC is.9 11. If “C” equals income at $500 billion, & MPC is.9, then an increase in Ig of $10 billion will change equilibrium GDP to ($400/$490/$510/$600) billion. conservative economist 12. A conservative economist would want tax (incr/decr) during recessioninflationary times a recession & (incr/decr) in “G” during inflationary times. liberal economist 13. A liberal economist would want tax (incr/decr) during an inflationrecessionary periods inflation & (incr/decr) in “G” during recessionary periods. inflationary gap 14. An inflationary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. recessionary gap 15. A recessionary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. increase GDP[but reduce military spending] 16. To increase GDP[but reduce military spending], we would combine two (domestic/overseas) bases into one (domestic/overseas) base. tax cut to expand the economy 17. A tax cut to expand the economy would (incr/decr) Y & (incr/decr) in. rates. tax increase to contract the economy 18. A tax increase to contract the economy would (incr/decr) Y & (incr/decr) IR. 500 500

71. increase equilibrium GDP by $400,000 19.To increase equilibrium GDP by $400,000, with a MPC of.5, a Keynesian economist would ( decrease “T” /increase “G” ) by $ 200,000. equilibrium GDP is $500 billion 20. Assume equilibrium GDP is $500 billion & MPS is.4. “G” collects taxes of of $22 billion and spends Now “G” collects taxes of of $22 billion and spends the entire amount the entire amount. As a result, equilibrium GDP will change to: ($445/$478/$522/$555). MPC of.5$12 billion 21. With a MPC of.5, a $12 billion increase increase “C” in “G” will increase “C” by ($12/$24/$36) bil. MPC of.5 22. With a MPC of.5 and the economy in a recessionary spending gap of $12 billion recessionary spending gap of $12 billion, we may conclude that the equilibrium is short of FE GDP ($12/$24/$36) billion short of FE GDP. Test Review 19-22

72. increase in Ig of $25 billion 23. An increase in Ig of $25 billion results in an increase in equilibrium income(GDP) of $50B, so the MPS is? contractionary fiscal policy 24. A contractionary fiscal policy results in a(n) (incr/decr) in output, and a(n) (incr/decr) in interest rates. Increasing T or decreasing G 25. Increasing T or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment..5inflationaryGDP GapinflationaryGDP Gap reducing government spending 26. With a MPC of.5, and the economy with an inflationary GDP Gap of $50B, G could eliminate this inflationary GDP Gap by reducing government spending by?.5current output at $500 bil. but FE output is $700 bil 27. With a MPC of.5 and current output at $500 bil. but FE output is $700 bil., correct fiscal policy would be to (increase G/decrease T) by $100 billion. [Incr T or Decr G] Test Review – AE & Fiscal Policy.5 $25 bil.

73. Test Review – AE & Fiscal Policy increase in Ig 28. An increase in Ig in an economy (increase)/decrease) GDP & (increase/decrease) C. recessionary economy 29. In a recessionary economy, at FEGDPsavingIg FE GDP, saving is (less than/more than) Ig. recessionary economy 30. In a recessionary economy, (actual Y/potential Y) exceeds (actual Y/potential Y). mixed-closed economyno Xnleakages 31. In a mixed-closed economy (no Xn), the leakages are? injections and the injections are? inflationary Gap 32. If the economy has an inflationary Gap, at FE GDPsaving FE GDP, saving (exceeds/is less than) Ig. equal increase in G&T of $25 bil 33. If there is an equal increase in G&T of $25 bil., then outputinterest rates[based on PL] output will (increase/decrease) & interest rates [based on PL] will (increase/decrease). [S & T] [G & Ig]

74. The End E-conE-con

75. Review for AE & Fiscal Policy “Econ, econ”

76. The M E, M T, & M BB Multipliers M E[G, Ig, or Xn] = 1/MPS = 1/.25 = 4 increase So, G increase of $20 bil. will incr Y by $80 bil. [$20x4=$80] decrease And a G decrease of $20 bil. will decrease Y by $80 bil. [ - $20x4= - $80 bil.] M T = MPC/MPS =. 75/.25 = 3 decrease So, T decrease of $20 bil. will incr Y by $60 bil. [$20 x 3=$60] increase And a T increase of $20 bil. will decr Y by $60 bil. [ - $20x3= - $60] M BB = 1 increase So, an increase in G&T of $20 bil. will incr Y by $20 bil. [$20x1= $20 ] decrease A nd a decrease in G&T of $20 bil. will decr Y by $20 bil.[ - $20x1= - $20] increase in expendituresincrease GDP Any increase in expenditures x the M will increase GDP. decrease in expendituresdecrease GDP Any decrease in expenditures x the M will decrease GDP.

77. AE [ C + Ig ] AE [ C + Ig ] (billions of dollars) o 45 o C onsumption C + I g I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 390470 370 390 410 430 450 470 490 510 530 550 Equilibrium GDP after $20 bil. Ig [MPC=.75] AE[C+Ig] [“Basic” or “Simple” economy] C =$450 Billion $530 510 490470 450 430 410390 370 + 20 Ig +80 S Private Closed

78. AE [C+Ig] AE [C+Ig] (billions of dollars) o 45 o C onsumption C + Ig+Xn I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 390470 370 390 410 430 450 470 490 510 530 550 (C [450] + I g[20] +M [10] + X [10] = GDP) Equilibrium GDP after X of $10 & M of $10 C = $450 Billion $530 510 490470 450 430 410390 370 S Private Open

79. ADDING THE PUBLIC SECTOR[“ ”] Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 390 470 550 Consumption C + I g + X n C + I g + X n + G Government Spending of $20 Billion $20 Billion Government Purchases and Equilibrium GDP S Mixed - Open Private-public - ROW $20 bil. on N ational D efense

80. $20 bil. incr in T [-$20 x 3 = -$60] ADDING THE PUBLIC SECTOR[“ ”] Incr. T by $20 bil.[MT = 3] Equilibrium GDP[-60] Aggregate Expenditures (billions of dollars) o 45 o Real domestic product, GDP (billions of dollars) 550 C + I g + X n + G C a + I g + X n + G 490 S Mixed-Open Private–public-ROW $20 billion

81. B alanced B udget [$2 Tril. “G”=$2 Tril. “T”] $2 Trillion G T Recession Incr G to $2.2 or or Decr T to $1.8 Deficit so higher I.R. Inflation Decr G to $1.8 or Incr T to $2.2 Surplus so Lower I.R. Budget So expansionary fiscal policy leads to higher interest rates. Deficit Wow! A surplus So, contractionary fiscal policy leads to lower interest rates. Gonna have to borrow

82. increase in Ig of $75B $300B 1. An increase in Ig of $75B results in an increase in equilibrium income(GDP) of $300B, so the MPS is? expansionary fiscal policy 2. An expansionary fiscal policy results in a(n) (incr/decr) in output, and a(n) (incr/decr) in interest rates. Increasing T or decreasing G 3. Increasing T or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment..75 inflationaryGDP Gap$80Bpositive equilibriumGDP Gapreducing government spending 4. With a MPC of.75, and the economy with an inflationary GDP Gap of $80B, G could eliminate this positive equilibrium GDP Gap by reducing government spending by?.60current output at $650 bil. but FE output is $700 billion 5. With a MPC of.60 & current output at $650 bil. but FE output is $700 billion, correct fiscal policy would be to (increase G/decrease T) by $20 billion. Test Review – AE & Fiscal Policy.25 $20 bil. [Decr T or Incr G] $2 Tr. G T

83. Test Review – AE & Fiscal Policy increase in Ig 6. An increase in Ig in an economy will GDPC (incr)/decr) GDP and (incr/decr) C. recessionary economy 7. In a recessionary economy, at FE GDPsaving FE GDP, saving is (less than/more than) Ig. inflationary economy 8. In an inflationary economy, (actual Y/potential Y) exceeds (actual Y/potential Y). complex economy C+Ig+G+Igleakages 9. In the complex economy (C+Ig+G+Ig), the leakages are? injections and the injections are? inflationary Gapat 10. If the economy has an inflationary Gap, at FE GDP FE GDP, saving (exceeds/is less than) Ig. equal increase in G&T of $10 bil 11. If there is an equal increase in G&T of $10 bil., then output will (incr/decr) & interest rates will (incr/decr). [S, T, & M] [G, Ig, X]

84. “OT”consumption 1. At income level “OT”, the volume of consumption is _____. “OT”saving 2. At income level “OT”, the volume of saving is _____. “APC” 3. The “APC” is equal to “1” at income level _____. Ig1“equilibrium GDP” 4. If Ig is Ig1, then “equilibrium GDP” is _____. Ig2“equilibrium GDP” 5. If Ig is Ig2, then “equilibrium GDP” is _____. Ig1Ig2equilibrium GDP 6. If Ig increases from Ig1 to Ig2, equilibrium GDP increases by _____. Ig1Ig2“MPC” 7. If Ig increases from Ig1 to Ig2, the “MPC” is equal to __________. OVOU“MPS” 8. As we move from income level OV to OU, the “MPS” is ________. “dissaving” 9. The economy is “dissaving” at income level _____. Consumption will be equal to income 10. Consumption will be equal to income at income level _____. TC CF OV OU OT UT BC/UT AE / VU OW OV W V U T B A 0 AE (C+Ig) AE (C+Ig2) AE (C+Ig1) Consumption F E D C Real GDP [Revised]

85. The next 3 slides will get you ready for the AE Quiz Hard Quiz Ahead

86. S 200 400 1,000 1,600 2,200 bil. 200 400 1,000 1,600 2,200 bil. 0 N Q K L M $2,200 $1,600 $1,000 $700 $400 J P I H G E F A B C D AE 3 [C + I g+ G + X n ] AE 3 [C + I g+ G + X n ] AE 2 [C+Ig+G] AE 1 [C+Ig] Consumption Real GDP AE [C+Ig+G+Xn] Inflat.Gap R ecess. Gap APC is “one” 1. The APC is “one” at letter: (J/H/G/A). Consumption will be equal to income(GDP) 2. Consumption will be equal to income(GDP) at (200/400/1000). shift from AE2 to AE3 3. A shift from AE2 to AE3 would be caused by a[an] (appreciation/depreciation) of the dollar. J to H, the simple multiplier 4. If there is a shift from J to H, the simple multiplier is: (2/3/4/5) FE GDP is OL & we are at AE2 5. If the FE GDP is OL & we are at AE2 then there is a(an): a. recessionary gap b. inflationary gap c. no gap FE GDP is OL & we are at AE1 6. If the FE GDP is OL & we are at AE1, the (reces./inflat.) gap is (AB/BC).

87. S 200 400 1,000 1,600 2,200 bil. 200 400 1,000 1,600 2,200 bil. 0 N Q K L M $2,200 $1,600 $1,000 $700 $400 J P I H G E F A B C D AE 3 [C + I g+ G + X n ] AE 3 [C + I g+ G + X n ] AE 2 [C+Ig+G] AE 1 [C+Ig] Consumption Real GDP AE [C+Ig+G+Xn] Inflat.Gap R ecess. Gap FE GDP is OL & we are at AE3 7. If the FE GDP is OL & we are at AE3, the (recessionary/inflationary) gap is: (BC or AB). 8. The equil. level of GDP at AE3 is ($1,000/$1,600/$2,200). FE is OL & we are at AE1, correct fiscal policy 9. If FE is OL & we are at AE1, correct fiscal policy would be to (incr/decr) “G” &/or (incr/decr) “T”. FE is OL & we are at AE3 10. If FE is OL & we are at AE3, correct fiscal policy would be to (incr/decr) “G” &/or (incr/decr) “T”. OKsaving 11. At income level OK, the volume of saving is: ($300/$700/$1,000). dissaving 12. The economy is dissaving GDP level: ($200/$400/$600).

88. FE GDP is OL & we are at AE1 15. If the FE GDP is OL & we are at AE1, a (recess/inflat) gap, we can saving conclude that at the equilibrium point, saving (is less than/equals/exceeds) FE level[$1,600], saving planned investment, but at the FE level[$1,600], saving (is less than/equals/exceeds) planned investment by (HI/GF). AE1, savings“C” 16. At AE1, savings total ($200/$300/$700) & “C” totals ($300/$700). AE1 [$1,000], G decreases both G & T by $400 billion 17. At AE1 [$1,000], the G decreases both G & T by $400 billion to balance the budget. With a simple multiplier of 5, the GDP (increases/decreases) to ($600/$1,000/ $1,600/$1,800). AE1($1,000 ), G spends $500 billionincreases taxes 18. At AE1($1,000 ), the G spends $500 billion & increases taxes by $500 billion by $500 billion to balance the budget. With a simple multiplier of 5 the GDP (increases/decreases) to ($500/$1,000/$1,500/$1,800). *Revision of the previous questions that looked like this. “J” to “H” 13. A shift from “J” to “H” would result in a MPC of: (HK/OK or IP/QK or HI/OK) 14. A shift from “J” to “H” would result in a MPS of: (HK/OK or IP/QK or HI/QK) 

89. Hard Quiz Coming Up

90. The AE Quiz The AE Quiz dissaving 1.T he economy is dissaving at a. OK b. OQ c. OM d. ON saving will be 2. Aggregate saving will be zero zero where GDP is a. $ 200 b. $ 400 c. $ 600 AE1, savings totals 3. At AE1, savings totals a. $300 b. $700 c. $1,000 FE GDP is OL 4. If the FE GDP is OL & we at AE3 are at AE3 the inflationary gap is a. BC b. AB c. CD FE GDP is OLat AE1 5. If the FE GDP is OL & we are at AE1 we can conclude that at the FE GDP: a. “S” exceeds Ig by GF b. Ig exceeds “S” by GF J to HMPC 6. Moving from J to H, the MPC is: a. FE/KL b. IP/OK c. IP/QK AE2 to AE3caused by 7. A movement from AE2 to AE3 would be caused by a(an) _______ of the dollar? A. appreciation b. depreciation FE GDP is OLat AE1recessionary gap is 8. If the FE GDP is OL & we are at AE1 the recessionary gap is: a. AB b. BC c. CD Consumption is equal to GDP 9. Consumption is equal to GDP at: a. 200 b. $400 c. $600 AE1 ($1,000 GDP) G increases G&T by $100 billion 10. At AE1 ($1,000 GDP), G increases G&T by $100 billion. W ith a “M” of 2, GDP increases to: a. $1,000 b. $1,100 c. $1,200 1. D 2. b 3. a 4. b 5. a 6. c 7. b 8. b 9. b 10. b Hard Quiz 

91. AE & Fiscal Policy Q uestions on 2000 AP E xam value of the spending multiplier 1. (81%) The value of the spending multiplier (M E ) decreases when a. tax rates are reduced d. government spending increases b. exports decline e. the marginal propensity to save increases c. imports decline Keynesian recommend 2. (75%) Which of the following policies would a Keynesian recommend during high unemployment and low inflation a period of high unemployment and low inflation? a. decreasing the MS to reduce AD b. decreasing taxes to stimulate AD c. decreasing government spending to stimulate AS d. balancing the budget to stimulate AS equilibrium income will 3. (47%) Which of the following best explains why equilibrium income will increase by more than $100 in response to a $100 increase inG increase by more than $100 in response to a $100 increase in G? a. Incomes will rise, resulting in a tax decrease. b. Incomes will rise, resulting in higher consumption. c. The increased spending raises the aggregate price level. d. The increased spending increases the money supply, lowering interest rates. e. The higher budget deficit reduces investment. Unexpected increases in inventories 4. (56%) Unexpected increases in inventories usually precede a. increases in inflationb. increases in importsc. stagflation d. decreases in productione. decreases in unemployment If MPS incr from.10 to.20, the M E would decrease from 10 to 5. more C The Multiplier ensures more C with each round.

92. economy on the right is 5. (63%) The economy on the right is experiencing currently experiencing a. inflation b. recession c. expansion d. stagflation e. rapid growth monetary policy 6. (77%) Correct monetary policy to reach FE GDP increase reach FE GDP is to increase a. the MS b. the RR c. discount rate d. taxes e. exports minimum increase in government 7. (36%) The minimum increase in government spending reach full employment spending to reach full employment is a. $2,000 b. $1,000 c. $500 d. $200 e. $100 simple Keynesian AE model[not AD/AS] 8. (58%) In the simple Keynesian AE model [not AD/AS] of an economy, changes in Ig or G lead to a change in which changes in Ig or G will lead to a change in which of the following? a. the price level b. the level of output and employment c. interest rates d. the AS curve closed-privateAPC is.75true 9. (83%) In a closed-private in which the APC is.75, which of following is true? a. If income is $100, then saving is $75.d. If income is $200, then “C” is $75 b. If income is $100, then “C” is $50e. If income is $500, then saving is $100 c. If income is $200, then saving is $50Full.Employ. C C+IgAE $500 $400 0 $800 $1,000 $2,000 SE A Determine what the “M” is going from A to E; then M X ? = $1,000

93. DI is $1,000 consumption is $700 MPC is.6 10. (63%) Suppose that DI is $1,000, consumption is $700, and the MPC is.6. DI then increases by $100 If DI then increases by $100, consumption and savings will equal which of the following? ConsumptionSavings a. $420 $280 b. $600 $400 c. $660 $320 d. $660 $440 e. $760 $340 Fiscal Policy Questions from 2000 Exam Fiscal Policy Questions from 2000 Exam inflationary gap can be eliminated EXCEPT 11. (73%) An inflationary gap can be eliminated by all of the following EXCEPT a. an increase in personal income taxesd. a decrease in G b. an increase in the MSe. a decrease in Xn c. an increase in the interest rate advantage of automatic stabilizers 12. (56%) A major advantage of automatic stabilizers in fiscal policy is that they a. reduce the public debt b. increase the possibility of a balanced budget c. stabilize the unemployment rate d. go into effect without passage of new legislation e. automatically reduce the inflation rate If $700 of $1,000 DI is consumed, then saving is $300. MPC of.6 means if DI increases by $100, then $60 more will be consumed & $40(.4) more will be saved (40%). The $60 added to the $700 already consumed = $760 consumed and the additional $40 saved = $340 saved. Which answer does not slow the economy?

94. contractionary fiscal policyAD 13. (70%) In the short run, a contractionary fiscal policy will cause AD, outputprice level output, and the price level to change in which of the following ways? ADOutputPrice level a. decreasedecreasedecrease b. decreaseincreaseincrease c. increase decreasedecrease d. increaseincreaseincrease Crowding out 14. (52%) Crowding out due to government borrowing occurs when a. lower interest rates increase private sector investment b. lower interest rates decrease private sector investment c. higher interest rates decrease private sector investment d. a smaller money supply increases private sector investment G wants to increase its spending by $100 billion 15. (41%) If, at FE, the G wants to increase its spending by $100 billion without increasing inflation in the short run, it must do which of the following? a. raise taxes by more than $100 billion c. raise taxes by less than $100 b. raise taxes by $100 billion d. lower taxes by $100 billion expansionary monetary policies 16. (42%) Compared to expansionary monetary policies adopted to expansionary fiscal policies counteract a recession, expansionary fiscal policies tend to result in a. less public spendingc. a high rate of economic growth b. higher interest ratesd. lower prices

95. 1995 AP Exam increase inincrease the value of the M E 17. (71%) An increase in which will increase the value of the M E ? a. The supply of moneyd. The marginal propensity to consume b. Equilibrium outpute. The required reserve ratio c. Personal income tax rates AS curve may be horizontal over some range 18. (61%) An AS curve may be horizontal over some range because within that range a. a higher PL leads to higher interest rates, which reduces the MS & “C” b. changes in the aggregate PL do not induce substitution c. output cannot be increased unless prices and interest rates increase d. rigid prices prevent employment from fluctuating e. resources are underemployed & an increase in AD will be satisfied without any pressure on the PL cause simultaneous increases in inflation & unemployment 19. (45%) What could cause simultaneous increases in inflation & unemployment a. a decrease in government spendingd. An increase in inflationary expectations b. A decrease in the money supplye. An increase in productivity c. A decrease in the velocity of money greatest increase in AD 20. (85%) Which of the following will result in the greatest increase in AD? a. A $100 increase in taxes b. A $100 decrease in taxes c. A $100 increase in government expenditures d. A $100 increase in government expenditures, coupled with a $100 increase in taxes e. A $100 increase in government expenditures, couples with a $100 decrease in taxes decrease in government spending 21. (65%) Which of the following will result from a decrease in government spending? a. An increase in outputd. A decrease in AS b. An increase in the price levele. A decrease in AD c. An increase in employment

96. private investment of $100 is added 23. (48%) If private investment of $100 is added to the economy, the equilibrium levels income and consumption will change of income and consumption will change in which of the following ways? Equil. LevelEquil. Level of Incomeof Income of Incomeof Income a. IncreaseDecrease a. IncreaseDecrease b. IncreaseIncrease b. IncreaseIncrease c. IncreaseNo change c. IncreaseNo change d. No changeIncrease d. No changeIncrease e. No changeNo change e. No changeNo change C Expenditures $700 0 $1,500 $2,000 Real Income S Questions 22-23 refer to the diagram(rt), which depicts an economy’s “C” function. MPC increasesequilibrium 22. (56%) If the MPC increases, the equilibrium levels of income and consumption will levels of income and consumption will change change in which of the following ways? Equil. Level Equil. Level Equil. Level Equil. Level of Income of Consumption of Income of Consumption a. No change No change a. No change No change b. No change Increase b. No change Increase c. Increase No change c. Increase No change d. Increase Increase d. Increase Increase e. Decrease Decrease e. Decrease Decrease A larger MPC means a smaller MPS, and a larger M. increase incomemore “C” this will increase income and result in more “C” at the new level of equilibrium income (GDP). C+Ig + $100 Ig C1C1C1C1 C2C2C2C2

97. C+Ig C+Ig+GAE$300 $200 0 $1,000 $1,500 0 $1,000 $1,500 GDP E F equilibrium at E 22. (61%) The graph indicates equilibrium at E closed economy for a closed economy without G. If the addition of G results in equilibrium at F addition of G results in equilibrium at F, which of the following is true? a. G is $300 and the multiplier is 5. b. G is $100 and the multiplier is 5. c. G is $100 and consumption increased by $500. d. G and Ig increase by $500. e. Consumption and GDP increase by $500 each. Keynesian theorydecreasing taxes and increasing G 23. (84%) According to Keynesian theory, decreasing taxes and increasing G will change consumptionunemployment most likely change consumption and unemployment in which of the following ways? ConsumptionUnemployment a. DecreaseNo change b. DecreaseNo change c. IncreaseDecrease d. IncreaseIncrease e. No change Decrease economy at full employment 24. (79%) In an economy at full employment, a presidential candidate proposes cutting increase T and reducing G the government debt in half in 4 years by increase T and reducing G. According to Keynesian theoryincrease Keynesian theory, implementation of these policies is most likely to increase a. unemploymentd. aggregate supply b. consumer pricese. the rate of economic growth c. aggregate demand

98. severe recession 25. (79%) If the economy is in a severe recession, which of the following is the fiscal policymost effective instimulating production and employment fiscal policy most effective in stimulating production and employment? a. Government spending increases. b. Government spending decreases. c. Personal income taxes are increased. d. The Fed sells bonds on the open market. e. The Fed buys bonds on the open market. decrease 26. (27%) Faced with a large federal budget deficit, the government decides to decrease expenditures tax revenuesby the same amountaffect expenditures and tax revenues by the same amount. This action will affect outputinterest rates output and interest rates in which of the following ways? OutputInterest Rates a. IncreaseIncrease b. IncreaseDecrease c. No changeDecrease d. DecreaseIncrease e. DecreaseDecrease crowding outpartially effects of a tax cut 27. (28%) If crowding out only partially offsets the effects of a tax cut, which of the changesinterest ratesGDP following changes in interest rates and GDP are most likely to occur. I nterest R ates GDP a. Increase Increase b. Increase Remain unchanged c. Increase Decrease d. Remain unchanged Increase e. Decrease Decrease An equal decrease in G & T [Let’s say by $10 billion] would decrease GDP by $10 billion decrease GDP by $10 billion. The decrease in GDP would decrease in interest rates decrease PL which would cause a decrease in interest rates. PartiallyGDP increases Partially means GDP increases. Starting from a balanced budget, the tax cut would put the G in deficit and the G borrowing would increase demand for money push up interest rates in the LFM and push up interest rates.