Question

2. How does an increase in income taxes on wage income affect the labor market and potential GDP?

3. How does an increase in income taxes on interest income affect the capital market and potential GDP?

4. Using the short-run aggregate supply curve, show the short-run effects of an increase in government purchases.

Answer the following multiple choice questions.

5. In 2009, U.S. government expenditures exceeded U.S. government tax revenues. As a result, the U.S. government had a budget ____ and U.S. government debt ____.

a. surplus; increased

b. surplus; decreased

c. deficit; increased

d. deficit; decreased

6. A decrease in income taxes on wages and interest income ____ equilibrium employment, ____ investment, and ____ potential GDP.

a. increases; does not change; increases

b. decreases; increases; decreases

c. increases; increases; increases

d. increases; decreases; does not change

7. The government purchases multiplier occurs because

a. changes in the price level affect people’s willingness to invest, consume, import and export.

b. a change in government purchases induces a change in consumption expenditure.

c. of government stabilization policies.

d. of income taxes.

8. Using fiscal policy, the best way to get the economy out of a recession in the short-run is to ____ government purchases of goods and services or ____ tax rates.

a. increase; increase

b. increase; decrease

c. decrease; increase

d. decrease; decrease

9. The economy is in a recession and the government’s budget deficit is $600 billion. We know that the ____ is less than $600 billion.

a. cyclical deficit

b. structural deficit

c. sum of the structural deficit plus cyclical deficit

d. None of the above answers is correct.

Answer 1

2) taxes on labor income disencourage workers to supply labor. So, if there is less supply of labor, Long rus supply curve shifts backwards, because there are less people willing to supply labor. Hence, potential GDP falls.

3) An interest income tax also reduces returns from capital, so there will be lesser people who wish to invest in capital. As amount of capital falls in the economy, long run supply curve shifts backwards and potential GDP falls.

4) In the short run aggregate supply-aggregate demand graph, an increase in government purchases increases the GP and price level in the economy in short run:

5) Increase of government expenditure over revenue leads to budget deficit, which increase government debt. So answer is (c)

6) A decrease in income taxes on wages and interest income increases equilibrium employment, increases investment, and increases potential GDP. Answer is (c)

7) A government expenditure multiplier works because government expenditure induces change in consumption expenditure. Answer in (b)

8) To coe out of recession, goverment undertakes expansionary fiscal policy which includes increase in government spending and decreased tax rates. Answer is (b)

9) In recession, the government deficit usually increases than the structural deficit. Answer is
(b)