Question

a.      What are automatic fiscal stabilizers? How do these stabilizers stabilize real GDP in the face of AD and AS shocks?

b.      What is the role of the simple multiplier [ 1/{1 - MPC(1 - t) - m}] in stabilization of the swings in real GDP?

c.       How the slope of the AD curve affects the stability of real GDP in the presence of AS shocks?

d.      How the automatic stabilizers depend on the sizes of MPC, t, and m.

Answer 1

A.

Automatic fiscal stabilizers are the benefits that help economy get corrected automatically. For example, transfer payments made by the government and unemployment insurance benefits are the automatic fiscal stabilizers that help an economy stabilize and remain in equilibrium. When there is a negative demand shock and AD decreases, then people get unemployed. In this case, unemployment benefits are paid to the workers who are unemployed. It compensates for the disposable income lost due to the loss of their jobs. These income of unemployment insurance benefits are spent that further pushes AD to the right and the economy is stabilized. On a similar note, when there is a positive supply shock and new jobs are created, then there is a reduction in unemployment benefits and other payments. It causes AD to shift to the left and the economy is stabilized again.  This the way, automatic stabilizers work to bring the economy back to the equilibrium level.

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