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Chapter 9 Fiscal Policy The basic economic problem is scarcity. Human wants are unlimited. Resources are limited. The basic goal in dealing with the problem of scarcity is to produce as much consumer satisfaction as possible with the limited resources available. Achieving each of the three macroeconomic goals (price level stability, full employment, and economic growth) will contribute toward reaching this basic goal. We saw in earlier chapters that the ideal quantity of total output is called Natural Real GDP. Natural Real GDP is the quantity of total output that results in the natural unemployment rate (full employment). The economy may be producing at Natural Real GDP in the short run, or the economy may be producing less than or more than Natural Real GDP, suffering from a recessionary gap or an inflationary gap. Whether or not the economy produces at Natural Real GDP in the short run may be affected by the government’s fiscal policy. Fiscal policy may also affect the level of economic growth in the long run (according to supply-side theory, discussed later in this chapter). Fiscal policy – changes in government expenditures and taxation to achieve macroeconomic goals. Changes in fiscal policy affect the federal government’s budget. The federal government’s annual budget could be balanced, with tax revenues equal to government expenditures. Typically, the federal government’s annual budget will be in deficit or surplus. Budget deficit – when government expenditures are greater than tax revenues. Budget surplus – when tax revenues are greater than government expenditures. A history of the federal government’s budget, detailing annual tax revenues, expenditures, and budget surpluses (or deficits) is provided in an appendix to this chapter. Keynesian Fiscal Policy Theory According to Keynesian theory, the level of Real GDP is determined by the level of Total Expenditures (see Chapter 8). An increase in Total Expenditures will cause an increase in Real GDP. A decrease in Total Expenditures will cause a decrease in Real GDP. The ideal level of Total Expenditures would cause the economy to produce at Natural Real GDP. But there is no guarantee that the level of Total Expenditures will be ideal. The level of Total Expenditures may be less than or greater than the level that will cause the economy to achieve Natural Real GDP. If Total Expenditures is less than the ideal, the result will be a recessionary gap. If Total Expenditures is greater than the ideal, the result will be an inflationary gap. The government may be able to move the level of Total Expenditures toward the ideal level (and move Real GDP toward Natural Real GDP) by using fiscal policy. Keynesian Fiscal Policy Theory and a Recessionary Gap According to Keynesian theory, fiscal policy can be used to move the economy toward Natural Real GDP. If the economy is in a recessionary gap, Real GDP is less than Natural Real GDP. To close a recessionary gap, Total Expenditures needs to increase. An increase in Total Expenditures can be caused by expansionary fiscal policy (an increase in government expenditures and/or a decrease in taxation). To close a recessionary gap, Keynesian theory calls for the use of expansionary fiscal policy. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Expansionary fiscal policy will alter the government’s budget situation. Assuming that the budget is initially balanced, expansionary fiscal policy will create a budget deficit. Thus, Keynesian theory calls for the use of deficit spending to close a recessionary gap. 9 - 1 Fiscal Policy
Example 1: If Real GDP is $18,000 billion and Natural Real GDP is $18,500 billion, the economy is in a recessionary gap. Keynesian theory calls for expansionary fiscal policy to close this recessionary gap. If the MPC is .80, the multiplier will be 5 (1 ÷ [1 – MPC]). With a multiplier of 5, an increase in government purchases of $100 billion would cause an eventual increase in Real GDP of $500 billion (Change in Real GDP = Initial Change x Multiplier). If Real GDP increases by $500 billion, the recessionary gap is closed and Real GDP equals Natural Real GDP. The graphs below illustrate the recessionary gap and the return to Natural Real GDP triggered by the increase in government purchases. Price Level Price Level Recessionary Gap Q N $18000B $18500B Real GDP SRAS Return to Natural Real GDP Q N $18000B $18500B Real GDP SRAS FOR REVIEW ONLY - NOT FOR DISTRIBUTION AD AD 1 AD2 Fiscal Policy 9 - 2
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PRINCIPLES OF ECONOMICS JEFF HOLT S
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Principles of Economics, 6th Editio
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16. Study Guide for Chapter 7 17. C
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11. Appendix: Book Review - “The
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20. Appendix: The NCAA Cartel 21. S
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Introduction: A Brief History of U.
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In the twentieth century, per capit
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Appendix: The 35 Largest National E
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Multiple Choice: ___ 1. The Jamesto
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2. Describe the economic cost of th
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Chapter 1 Scarcity and Choices The
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Example 5B: At the end of 1982, the
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Example 11: When Cindy quits her jo
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consequences may result in failure
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An upward sloping curve (as in Exam
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In making decisions, humans tend to
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5. ______________________ _________
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___ 13. If the value of one variabl
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Y Point X Y A 0 1 B 3 3 C 6 5 D 9 7
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Chapter 2 Trade and Economic System
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Example 4B: The following quantitie
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1. An increase in the quantity of r
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3. For whom to produce? This is det
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The graph below illustrates the shi
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The two primary economic systems ar
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___ 12. The capitalist vision sees
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___ 25. According to the book “Ca
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Chapter 3 Demand, Supply, and Equil
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. For inferior goods, income and de
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The same information can be placed
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Not only does a free market elimina
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$7 - 6 - 5 - S 3 S1 S 2 Price 4 - 3
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Example 17: The graph below illustr
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Questions for Chapter 3 Fill-in-the
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___ 12. Assuming a market originall
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$8 - 7 - 6 - 5 - Price 4 - 3 - 2 -
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Chapter 4 Inflation and Unemploymen
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Computing the Rate of Inflation The
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Full Employment Though unemployment
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3. Cyclical unemployment - due to d
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During the Great Depression, the ec
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Appendix: Think Like an Economist -
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Answer questions 8. and 9. based on
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___ 25. The extension of unemployme
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Chapter 5 Measuring Total Output: G
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5. Leisure. Leisure time is by defi
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The U.S. is a high per capita GDP c
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Example 17: In “An International
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Page 108 and 109: Example 5B: The price of crude oil
Page 110 and 111: Price Level Real GDP SRAS AD 2 AD 1
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Page 118 and 119: Chapter 7 Classical Economic Theory
Page 120 and 121: Notice that the investment demand c
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Page 124 and 125: Example 6B: When the economy is in
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Page 132 and 133: Chapter 8 Keynesian Economic Theory
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Page 152 and 153: Example 5A: The federal government
Page 154 and 155: The Laffer Curve What will happen t
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Page 162 and 163: Chapter 10 Money, Money Creation, a
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Page 166 and 167: Looking at the balance sheet below,
Page 168 and 169: Demand-side One-shot Inflation Exam
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Page 186 and 187: Relaxed Standards for Mortgage Loan
Page 188 and 189: The Bursting of the Housing Bubble
Page 190 and 191: On February 17, 2009, the federal g
Page 192 and 193: Fed policies caused short-term inte
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Chapter 12 Monetary Policy The basi
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2. A change in aggregate demand (AD
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Monetarist Transmission Mechanism C
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3. Borrowers do not have to seek ou
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Appendix: Book Review - “The Age
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Questions for Chapter 12 Fill-in-th
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___ 16. The primary source of incom
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7. According to Alan Greenspan, wha
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Chapter 13 Taxes, Deficits, and the
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Example 5: In 2015, Taxpayer A had
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of $5 and a quantity of 10 units. T
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The complexity of the tax law also
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the current government spending and
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cut of 1964. The top rate was lower
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___ 6. Federal excise taxes: a. are
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3. How would eliminating the loopho
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Chapter 14 Economic Growth The basi
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2. Labor. Labor can contribute to e
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estricting international trade (e.g
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An improvement in technology (e.g.
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The table below shows the economic
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will increase both Real GDP and per
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___ 8. Which of the following is co
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___ 26. The opinion that economic g
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Chapter 15 Less Developed Countries
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Example 8: Countries A, B, C, and D
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Obstacles to Economic Development f
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c. Restrictions on international tr
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Appendix: Book Review - “The Powe
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Example 25: In Brazil, about half t
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Study Guide for Chapter 15 Chapter
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___ 13. Among the counterproductive
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4. List four ways that governments
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Chapter 16 International Trade The
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Other Benefits of Free Internationa
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Example 6: The graph below illustra
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competitive disadvantage. But dumpi
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is only 25% as productive as before
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Smith was skeptical of government a
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___ 4. For Country X, what is the o
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___ 18. Frédéric Bastiat’s “P
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4. On the graph below: (1) What is
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Chapter 17 Elasticity We are often
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Example 4A: What is price elasticit
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Example 5A: Gertie’s Gas and Go i
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Example 10A: When the price of Good
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Example 13B: On the graph below, su
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$7 - 6 - 5 - Price 4 - 3 - 2 - 1 -
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In the long run, would the deadweig
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___ 7. The factors that determine w
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3. a. Which price (or prices) from
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Chapter 18 Utility The basic econom
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Nonetheless, society generally assu
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Example 9: Capital City operates a
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Marginal rate of substitution - the
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The diamond-water paradox is the ob
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Complete the table below to answer
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4. The graph below shows indifferen
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Chapter 19 The Firm The basic econo
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than contributing to team productio
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1. Difficulty in raising large amou
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Corporations also use self-financin
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Example 24: A blacksmith who produc
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For financing needs, proprietorship
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___ 13. Corporations: a. are comple
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5. List two things that the absence
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Chapter 20 Production and Costs The
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In Example 5B, Birdwell finds that
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variable cost initially decreases,
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Quantity TC MC AFC AVC ATC 0 240 X
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If the scale of operation is increa
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average total cost. Average fixed c
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___ 11. Concerning the cost curves:
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5. Complete the following cost tabl
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Chapter 21 Perfect Competition The
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Even though a perfect competitor ca
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Example 6C: This example builds on
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At what price will there be neither
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Appendix: Perfect Competition in th
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Multiple Choice: ___ 1. A perfect c
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___ 17. Perfect competition: a. req
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Answers for Chapter 21 Fill-in-the-
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Chapter 22 Monopoly Of the four mar
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3. Exclusive ownership of an essent
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maximizing quantity (4 units) creat
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$22 - 20 - 18 - 16 - 14 - Deadweigh
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2. Negotiating, beginning at a high
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Legal barriers are created by gover
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___ 8. The slope of the demand curv
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Price Quantity 3. List some of the
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Chapter 23 Monopolistic Competition
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For Percomp (the perfect competitor
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Example 7A: The graph below represe
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Example 9: The Organization of the
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Example 12 illustrates the dilemma
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its current price and quantity. The
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___ 14. Game theory: a. is a method
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Answers for Chapter 23 Fill-in-the-
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Chapter 24 Factor Markets The basic
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$ $240 - 200 - 160 - 120 - 80 - 40
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Since producers will attempt to equ
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2. Differences in nonmoney aspects
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were his strikeouts, walks, and hom
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___ 3. To maximize profits, a produ
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___ 19. According to the book, “M
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Multiple Choice: 1. a. 8. c. 15. d.
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Chapter 25 Labor Unions The primary
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The elasticity of demand for union
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Example 4A: Assume that the graph b
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Notice from the graph in Example 6
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Wage Factory A Quantity of Labor S
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As a cartel, a labor union faces a
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___ 10. For a monopsony: a. there i
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3. The graph below represents a lab
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Chapter 26 Interest, Present Value,
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An increase in expected rates of re
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An asset is valuable because we exp
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Example 13B: General Ordnance prove
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Appendix: Present Value Table One f
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___ 4. An increase in expected rate
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Problems: 1. List and explain the t
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Chapter 27 Market Failure The basic
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External Benefit If a market genera
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Example 2: To encourage the consump
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$100 - 90 - 80 - MSC 70 - $ 60 - 50
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A common good is nonexcludable. Non
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___ 5. What government policy would
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4. Based on the information on the
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Chapter 28 Public Choice and Govern
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Candidates and the Median Voter Mod
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Example 8: According to State and F
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Example 10: When Elvis Presley was
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4. Pessimistic bias. This is the te
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___ 5. An elected official will: a.
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2. If a certain policy will yield s
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Chapter 29 Government Regulation of
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underproduction is the amount that
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micromanagement results in business
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market. They may agree with their c
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Questions for Chapter 29 Fill-in-th
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___ 10. The public interest theory
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4. List the four types of costs imp
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Chapter 30 Agriculture and Health C
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weather may cause bumper crops. Bad
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Security and Rural Investment Act o
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Example 12: From 1960 to 2013, the
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1. NHI would provide universal heal
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d. Insurance providers are not allo
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Answer questions 7. through 10. by
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___ 21. If there were no individual
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Chapter 31 Income Distribution and
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Income is more equally distributed
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over a typical career is the accumu
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Ideal Income Redistribution The ide
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Poverty - a family whose income fal
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Appendix: Income Inequality around
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How is this story an analogy for th
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___ 2. In 2013, the Lowest Income 6
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Problems: 1. Explain the two primar
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Absolute advantage - when one natio
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Fiat money - money by government de
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Nonrivalrous good - a good for whic
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Absolute advantage, 16-9 Absolute e
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“Company town”, 25-6 Comparativ
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Eli Lilly and Company, 22-1 Emergen
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Houston, Texas, 15-10 Human capital
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Market, 3-1, 3-8-9 Market basket, 4
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Political bias, 9-4, 12-7 Political
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Short run production, 20-2-3 Short-
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Upturns, 9-4 USDA, 27-9, 30-1-2, 30
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