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Which of the following would be considered a fiscal policy action?
Unemployment benefit payments to the unemployed are an automatic stabiliser.
True
What is an 'automatic stabiliser'?
A tax or form of government expenditure that has the effect of reducing the size of business cycle fluctuations.
Discretionary fiscal policy is when the government changes the levels of expenditure or taxation to achieve a extbf{______}.
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If real equilibrium GDP is below the long-run aggregate supply curve, an appropriate fiscal policy would be to:
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If the government does not use fiscal policy, real GDP will always remain at its potential level.
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To keep real GDP at its potential level in 2023, the government should extbf{______}.
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Match the following terms with their definitions:
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If the economy is growing beyond potential GDP, which fiscal policy would help return it to long-run aggregate supply?
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An increase in government purchases typically causes Real GDP to fall.
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What is the Marginal Propensity to Consume (MPC) given in the context of the government's $1 billion increase in purchases?
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If the MPC is 0.8 and the government increases purchases by $1 billion, Real GDP will increase by _____.
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Match the following terms to their corresponding definitions:
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Why might the increase in Real GDP from government purchases be less than predicted?
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Tax cuts generally have a higher multiplier effect than government purchases.
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What were some economic impacts of COVID-19 on the Australian economy mentioned in the content?
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Study Notes
Fiscal Policy Actions
- Fiscal policy refers to government actions that influence the economy through spending, taxes, and transfer payments.
- A fiscal policy action can be a city changing its land tax rates, a federal government providing subsidies for hybrid cars, or a tax cut designed to stimulate spending during an economic contraction.
- Foreign aid given to Indonesia is an example of an international policy, not a domestic fiscal policy action.
Automatic Stabilizers
- Automatic stabilizers are features of the economy that automatically reduce the severity of business cycle fluctuations.
- Examples of automatic stabilizers include unemployment benefit payments to the unemployed.
- Increases in government spending on schools, while considered a fiscal policy, are not automatic stabilizers.
- Interest rate changes are considered monetary policy, not fiscal policy.
- Reductions in nominal wages as inflation rates rise are a market response to inflation, not a government policy.
Discretionary Fiscal Policy
- Discretionary fiscal policy involves deliberate changes in government spending and taxation levels to achieve macroeconomic goals.
- This includes, for example, increasing government purchases or cutting taxes during a recession.
- Existing taxation policy automatically smoothing out business cycle fluctuations is an example of an automatic stabilizer, not discretionary fiscal policy.
- The Reserve Bank of Australia is responsible for monetary policy, not fiscal policy.
Fiscal Policy to Address GDP Gaps
- When real equilibrium GDP is below the long-run aggregate supply curve, it indicates a recessionary gap.
- To address this, an appropriate fiscal policy would be to increase government purchases and increase the budget deficit.
- Increasing individual income taxes or business income taxes would further decrease aggregate demand, deepening the recession.
Fiscal Policy to Address Inflationary Gaps
- When the economy is growing beyond potential GDP, it indicates an inflationary gap.
- To bring the economy back to long-run aggregate supply, the government should increase taxes.
- Increasing liquidity and decreasing interest rates are monetary policy tools, not fiscal policy.
- Increasing government purchases would further stimulate the economy, worsening the inflationary gap.
- Increasing oil prices are a supply-side shock and not a fiscal policy tool.
Multiplier Effect of Government Spending
- When the government increases its purchases by $1 billion, the multiplier effect will cause Real GDP to increase by more than $1 billion.
- The multiplier effect is determined by the marginal propensity to consume (MPC), which represents the fraction of additional income that households spend.
- In this case, with an MPC of 0.8, the multiplier is 5.
- Real GDP will increase by $5 billion.
Impact of Government Purchases on Real GDP
- The increase in government purchases directly increases aggregate demand.
- This leads to increased production by businesses.
- Increased production requires more workers, leading to higher employment.
- Increased employment results in higher incomes for workers, further boosting spending (due to the MPC).
- This process continues, with each round of spending increasing Real GDP by a smaller amount than the previous round.
Factors Reducing the Multiplier Effect
- In reality, the increase in Real GDP is likely to be less than predicted.
- This is due to several factors, including:
- Import leakages: Some of the increased spending may be on imported goods, reducing the impact on domestic production.
- Tax leakages: Some of the increased income will be paid in taxes, reducing the amount available for spending.
- Savings leakages: Some of the increased income will be saved instead of spent, reducing the impact on aggregate demand.
Stimulus Package: Government Purchases vs. Tax Cuts
- The multiplier effect for government purchases is generally larger than for tax cuts.
- This is because not all tax cuts are spent.
- For example, if the government cuts taxes by $1 billion, households may only spend $600 million of this, with the remaining $400 million saved.
- Government purchases, however, are spent directly, leading to a larger initial increase in aggregate demand.
The Economic Impact of the COVID-19 Pandemic
- The COVID-19 pandemic caused a significant decrease in aggregate demand due to:
- Reduced consumer spending as people stayed home and businesses closed.
- Reduced investment spending as businesses faced uncertainty and reduced profits.
- Reduced export demand as global trade slowed down.
- The pandemic also caused a decrease in short-run aggregate supply due to:
- Disruptions to supply chains and production processes.
- Labor shortages as workers became sick or were unable to work.
- Increased costs for businesses due to safety measures and supply chain disruptions.
- The pandemic also caused a decrease in long-run aggregate supply due to:
- Reduced investment in new capital and technology.
- Loss of human capital as workers lost their jobs and skills.
- Decreased productivity due to social distancing measures and other disruptions.
- The subsequent government interventions, including travel restrictions, lockdown measures, and stimulus packages, had significant impacts on aggregate demand and supply.
- In the short run, these interventions were necessary to contain the spread of the virus and to provide support to businesses and households.
- However, in the long run, these policies may have had unintended consequences, such as increased government debt and potential distortions in the economy.
The Impact of Job Losses and Discouraged Workers
- The job losses and discouraged workers indicate a decrease in labor force participation.
- This contributes to a decrease in potential GDP as there is a smaller pool of available workers.
- It also reduces aggregate supply, as businesses have fewer workers available to produce goods and services.
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Description
This quiz explores the concepts of fiscal policy actions and automatic stabilizers in the economy. Participants will learn how government spending, taxes, and various policies impact economic stability. Test your understanding of these critical components that help manage economic fluctuations.
