Question

1. If inflation is a major issue in the economy, what would be the correct fiscal policy response from an economic perspective? Why would members of Congress be unlikely to support such actions?

                        2.   Why is the tax multiplier smaller than the government spending multiplier?

                          3. Explain how a larger government budget deficit increase the magnitude of the crowding-out effect?

                           4. When an economy is already at full employment, what is the outcome of expansionary fiscal policies to employment, inflation, real output, and deficits (assuming no changes in tax rates)?

5. Explain the effects of the following actions on equilibrium income, assuming that the marginal propensity to consume is 0.8

a. Government purchases rise by $40 billion.

b. Taxes fall by $40 billion.

Answer 1

1. Inflation is the phenomenon of gradual rise in the price level of the economy. It happens either when the aggregate demand in the economy increases or the aggregate supply in the econmy decreases. If the government pursues fiscal policy in order to bring down inflation, then it must increase taxes, or reduce government spending so as to bring down the aggregate demand in the economy, which would eventually cause a decrease in the price level.

The increase in the taxes would reduce the disposable income of the consumers, and the sonsumers ill be worse off. This may not be liked by the congress.

2. The impact of taxation upon the output of the economy is a secondary effect, as the taxes change the dispsable income directy, which further acts upon the consumption, which changes output. However, the change in government spending would bring about change in the output of the economy directly.

Mathematically,

Government multiplier:

The tax multipier is:

Mathematically also, the tax multiplier is smaller than the government multiplier.