Economics: Government Spending Effects

Questions and Answers

What is crowding out?

A type of investment strategy

Decrease in government spending

Increase in government spending without raising taxes (correct)

An economic term for savings

What is supply-side economics?

A school of economics that believes tax cuts can help an economy by raising supply.

The process of crowding out begins when government spending becomes larger than _______.

tax revenues

What are the effects of a decrease in taxes under a recessionary gap?

Increase in income (Y), increase in consumption (C), increase in aggregate demand (AD), and increase in supply of labor. Signup and view all the answers

What happens to aggregate supply under an inflationary gap?

AS shifts to the left Signup and view all the answers

Match the types of lags associated with supply-side economics:

Data lag = The time between a problem occurring and policy notice Wait and see lag = The time for policymakers to decide on a policy Legislative lag = The time needed for Congress to approve a fiscal policy Transmission lag = The time needed to implement the approved fiscal policy Effectiveness lag = The time to see the impact of fiscal policy on Real GDP Signup and view all the answers

Study Notes

Crowding Out

Occurs when increased government spending, without tax hikes, raises the deficit.
This leads the government to borrow more from the loanable funds market, raising interest rates.
Higher interest rates discourage investment and consumption.

Complete Crowding Out

Graph showing the relationship between government spending, deficit, and its effects on interest rates is not provided.

Supply-Side Economics

An economic theory advocating for tax cuts as a means to enhance overall economic supply.
Emphasis on the relationship between taxation and economic growth.

Supply-Side Economics in a Recessionary Gap

A decrease in taxes (T) can lead to:
- Increased income (Y).
- Higher consumption (C), boosting aggregate demand (AD).
- Improved workforce incentives and supply of labor, ultimately increasing aggregate supply (AS).
For low and middle-income workers, lower taxes enhance work incentives; however, for high-income workers, reduced taxes may lead to increased leisure and decreased AS.

Graph of Supply Side Under a Recessionary Gap

Graph not available, but indicates that AS shifts right leading to decreased prices (P) and increased GDP.

Process of Crowding Out

Begins when government spending exceeds tax revenues.
Results in a positive government deficit, necessitating borrowing to finance this deficit.
Increased borrowing raises interest rates throughout the economy.
Higher interest rates elevate the opportunity cost of borrowing, diminishing consumption and investment.

Graph of Supply Side Under an Inflationary Gap

Graph not available, shows AS shifting left, resulting in higher prices (P) and decreased GDP.

Lags Associated with Supply-Side Economics

Data Lag: Delay between the emergence of a problem and policymakers' awareness.
Wait and See Lag: Time taken for policymakers to determine a suitable response.
Legislative Lag: Duration for Congress to approve necessary fiscal policies.
Transmission Lag: Time required to implement approved fiscal policies.
Effectiveness Lag: Interval needed to observe the impact of fiscal policies on real GDP.

Description

This quiz explores the concepts of crowding out and supply-side economics, particularly how government spending and tax cuts influence interest rates and aggregate demand during different economic conditions. Analyze the impact of increased government spending on deficits and investment levels in this informative assessment.