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

1. Government purchases rise by $40 billion.

2. Taxes fall by $40 billion.

Answer 1

Answer 1.

When there is an inflationary pressure in the economy, it means that the economy is growing a lot quicker and the potential output is higher than the genuine output. Therefore, the government needs to follow a contractionary fiscal policy. In contractionary fiscal policy, the government needs to increase government rates or cut expenses or do both. In any case, the members of the Congress are unlikely to make these strides as these will harm their electoral prospects. At the point when the government cuts expenses, it needs to reduce spending on numerous social and government assistance programs. Additionally, an increase in tax reduces the disposable income of individuals. Therefore, both these arrangements are despised by the public in general. In this way, the members of Congress are unlikely to support such actions which are not supported by the public in general.

Answer 2.

In the event that the full multiplier for G (for example ignoring crowding out effects) is = change in G/Multiplier

At that point the tax multiplier is = change in T x marginal propensity to consume/multiplier

since the mpc is between 0 and 1 the tax multiplier is less.

Instinctively it isn't difficult to perceive any reason why, the change tax enters spending decisions through consumption and consumption is dependant on the mpc. Though as G affects spending decisions directly - it is an injection into the economy that doesn't need to work through some indirect source to affect the economy.

Answer 3.

A larger government budget deficit increase the magnitude of the crowding effect because of the fact that a larger government deficit increases the demand for borrowing , increases the magnitude of the increase in loan costs , crowding out more private sector investment as a result.