Fiscal Policy and Budget Concepts
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Questions and Answers

What indicates that a budget is balanced?

  • A surplus is present in the budget.
  • Government expenditures exceed tax revenues.
  • Tax revenues are lower than transfer payments.
  • Government expenditures equal tax revenues. (correct)

When does a budget surplus occur?

  • Transfer payments are higher than tax revenues.
  • Total expenditures are higher than total revenues.
  • Government debt decreases significantly.
  • Tax revenues exceed government expenditures. (correct)

Which of the following describes a budget deficit?

  • It occurs when government expenditures surpass tax revenues. (correct)
  • It happens when tax revenues exceed government expenditures.
  • It leads to an increase in transfer payments.
  • It is always temporary and resolved quickly.

What is fiscal policy primarily concerned with?

<p>Changes in government spending and taxation. (C)</p> Signup and view all the answers

Which statement about transfer payments is correct?

<p>They can contribute to a budget deficit. (B)</p> Signup and view all the answers

Under which condition is monetary policy said to work against fiscal policy?

<p>When changes in interest rates affect government revenues. (B)</p> Signup and view all the answers

What is most likely to result from persistent budget deficits?

<p>An increase in national debt. (B)</p> Signup and view all the answers

Which situation does NOT illustrate a successful fiscal policy?

<p>Increasing government spending without a corresponding revenue increase. (C)</p> Signup and view all the answers

What action does Keynesian theory suggest to eliminate a recessionary gap?

<p>Decrease taxes (A), Increase government purchases (D)</p> Signup and view all the answers

According to Keynesian theory, how can an inflationary gap be addressed?

<p>Decrease government purchases (A), Increase taxes (B)</p> Signup and view all the answers

Which of the following statements about Keynesians is true?

<p>They believe that equilibrium may exist at less than full employment. (C)</p> Signup and view all the answers

What does Keynesian theory indicate should happen when private spending decreases?

<p>Government spending should compensate the decrease. (C)</p> Signup and view all the answers

What best describes complete crowding out in an economic context?

<p>A scenario where government spending reduces private sector investment entirely. (A)</p> Signup and view all the answers

Which fiscal policy action is most appropriate to mitigate high inflation?

<p>Increase taxes (B)</p> Signup and view all the answers

What role does fiscal policy play according to Keynesian economists?

<p>Stabilizing the economy by managing government spending and taxation. (A)</p> Signup and view all the answers

If government and private spending are perfectly offsetting each other, this is indicative of which crowding out scenario?

<p>Complete crowding out (B)</p> Signup and view all the answers

What does a curve showing the relationship between tax rates and tax revenues represent?

<p>Laffer curve (C)</p> Signup and view all the answers

If Elaine's taxable income increases by $1 and her tax payment increases by $0.28, what is her marginal tax rate?

<p>28 percent (B)</p> Signup and view all the answers

Which statement is true when comparing points A and B on a tax rate and revenue graph?

<p>At B, tax rates are higher than at A, but tax revenues are the same. (C)</p> Signup and view all the answers

Which of the following is caused by a decrease in government purchases?

<p>Decrease in economic output (A)</p> Signup and view all the answers

The relationship described by a Laffer curve implies which of the following?

<p>There is a certain tax rate at which revenue is maximized. (A)</p> Signup and view all the answers

What would be the effect of an increase in taxes on individual disposable income?

<p>Decrease in disposable income (C)</p> Signup and view all the answers

If tax revenues are constant while tax rates vary, which statement could be true?

<p>Higher tax rates lead to lower compliance. (A), Tax evasion increases with higher rates. (D)</p> Signup and view all the answers

Which of the following would likely result from lowering the marginal tax rate?

<p>Increased incentive for work (A)</p> Signup and view all the answers

What is the expected outcome if government purchases increase by $100 billion and incomplete crowding out occurs?

<p>The AD curve will shift to the right. (C)</p> Signup and view all the answers

Which statement correctly describes Smith’s and Jones’ beliefs regarding government purchases and the AD curve?

<p>Smith believes in incomplete crowding out, while Jones believes in complete crowding out. (A)</p> Signup and view all the answers

If the economy is in a recessionary gap with incomplete crowding out, which scenario is most likely?

<p>The AD curve will shift to the right. (D)</p> Signup and view all the answers

What would happen if there is complete crowding out in response to increased government spending?

<p>The effect on the AD curve will be neutral. (A)</p> Signup and view all the answers

Which description aligns with the expected effects of expansionary fiscal policy during a recessionary period?

<p>The AD curve will shift to the right. (B)</p> Signup and view all the answers

Which concept describes the relationship between increased government spending and private sector investment when complete crowding out occurs?

<p>Government spending replaces private spending dollar for dollar. (D)</p> Signup and view all the answers

What implication does incomplete crowding out have for the AD curve?

<p>The AD curve will shift right, but not entirely. (C)</p> Signup and view all the answers

What is the consequence of government purchases rising by $120 billion in a scenario of complete crowding out?

<p>The AD curve will remain unaffected. (A)</p> Signup and view all the answers

What is Smith's likely stance on fiscal policy if he believes the economy is self-regulating during a recessionary gap?

<p>He is less likely to advocate expansionary fiscal policy than Jones. (D)</p> Signup and view all the answers

Which statement about government spending leading to crowding out is accurate?

<p>Increased government purchases can decrease private spending on similar goods. (B)</p> Signup and view all the answers

Which of the following situations does NOT represent crowding out?

<p>Government spending increasing while households maintain their spending levels. (D)</p> Signup and view all the answers

What evidence would indicate zero crowding out?

<p>Government purchases rise with no corresponding change in Real GDP. (A)</p> Signup and view all the answers

Which expression correctly describes the consequence of a budget deficit on loanable funds?

<p>A decrease in the supply of loanable funds, causing interest rates to rise. (A)</p> Signup and view all the answers

If Smith believes that wages are inflexible downward, what would this suggest about his economic outlook?

<p>He may be cautious about advocating cuts in government spending. (A)</p> Signup and view all the answers

Which of the following is an implication of crowding out in an economy?

<p>Private investment may decrease as government borrowing increases. (C)</p> Signup and view all the answers

Which factor does NOT contribute to crowding out?

<p>Decreased public spending without a shift in private spending. (B)</p> Signup and view all the answers

What is a likely reason a Keynesian economist advocates for expansionary fiscal policy in a recessionary gap?

<p>The economist believes the economy is stuck in a recession and there will be no crowding out. (B)</p> Signup and view all the answers

If government spending increases by $120 billion, which statement about private expenditures is most accurate?

<p>Private expenditures are likely to decrease by an equivalent amount due to crowding out. (D)</p> Signup and view all the answers

Which of the following describes a situation where the AD curve is downward-sloping?

<p>Higher prices result in lower quantity demanded within the economy. (A)</p> Signup and view all the answers

What does complete crowding out imply in economic terms?

<p>Increased government spending does not affect overall demand in the economy. (A)</p> Signup and view all the answers

In the Keynesian framework, what aspect is assumed about monetary policy effectiveness during a recession?

<p>It is often ineffective due to liquidity traps and low confidence. (D)</p> Signup and view all the answers

If the SRAS curve is upward-sloping, what does this signify about the relationship between price level and output?

<p>Rising prices encourage firms to increase their output. (C)</p> Signup and view all the answers

Which statement accurately describes the behavior of the AD curve in a recessionary gap?

<p>It shifts to the left, indicating a decline in total demand. (B)</p> Signup and view all the answers

Flashcards

Balanced Budget

A state of accounts where government expenditures are equal to tax revenues.

Budget Surplus

When tax revenues exceed government expenditures.

Budget Deficit

A shortfall where government expenditures exceed tax revenues.

Fiscal Policy

Changes in government spending and taxation to manage the economy.

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Government Expenditures

Total amount the government spends.

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Tax Revenues

Total income collected by the government from taxes.

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National Debt

The total amount of money a country owes.

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Transfer Payments

Payments made by the government to individuals or groups without direct exchange for goods or services.

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Contractionary Fiscal Policy

Government policies aimed at reducing aggregate demand by decreasing government spending or increasing taxes.

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Expansionary Fiscal Policy

Government policies aimed at increasing aggregate demand by increasing government spending or decreasing taxes.

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Laffer Curve

A curve showing the relationship between tax rates and tax revenues. It suggests that tax revenue may initially increase with higher rates but eventually reach a peak and then decline.

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Marginal Tax Rate

The tax rate applied to the last dollar of taxable income earned.

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How does tax revenue change as tax rates rise?

Tax revenue initially increases as tax rates rise, but eventually, it reaches a peak and then declines, according to the Laffer Curve.

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What are the two main tools of fiscal policy?

Government spending and taxation. By adjusting these, the government can influence the economy.

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What happens when government spending increases?

This stimulates the economy, leading to higher aggregate demand and potentially higher GDP.

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What happens when taxes decrease?

This also stimulates the economy by putting more money in people's pockets, leading to higher spending and potentially higher GDP.

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Recessionary Gap

A situation where the economy is operating below its potential output, resulting in unemployment and underutilized resources.

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Inflationary Gap

A situation where the economy is operating beyond its potential output, leading to increased prices and inflation.

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Keynesian Theory

An economic theory that emphasizes the role of government spending and taxation in managing the economy and influencing aggregate demand.

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How to Eliminate a Recessionary Gap

To eliminate a recessionary gap, Keynesian theory suggests increasing government spending or decreasing taxes to boost aggregate demand.

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How to Eliminate an Inflationary Gap

To eliminate an inflationary gap, Keynesian theory suggests decreasing government spending or increasing taxes to reduce aggregate demand.

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Laissez-Faire Approach

An economic philosophy that advocates for minimal government intervention in the economy.

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Equilibrium Less Than Full Employment

A situation where the economy reaches a state of balance but with some resources still available for use.

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Fiscal Policy for Stabilization

The use of government spending and taxation to influence the economy and achieve desired macroeconomic goals, like full employment.

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Crowding Out

When government spending displaces private investment by increasing interest rates. This can happen when the government borrows money to finance its spending.

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Complete Crowding Out

A situation where government spending completely displaces private investment. This means that the increase in government spending leads to a decline in private investment by an equal amount.

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Incomplete Crowding Out

A situation where government spending partially displaces private investment, leading to a smaller reduction in private investment than the increase in government spending.

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Downward-Sloping AD Curve

A representation of the inverse relationship between the price level and the quantity of goods and services demanded in the economy. As prices decrease, consumers demand more goods and services.

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Upward-Sloping SRAS Curve

A representation of the relationship between the price level and the quantity of goods and services supplied in the short run. As prices increase, businesses are encouraged to produce more goods and services.

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Flexible Prices

Prices that can adjust quickly in response to changes in supply and demand. This allows the economy to respond more quickly to shocks.

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Shifting the AD Curve to the Right

An increase in aggregate demand, typically caused by factors like increased government spending, lower taxes, or higher consumer confidence.

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What does incomplete crowding out mean in relation to fiscal policy?

It means that government spending can still have a positive impact on aggregate demand, even if some private investment is reduced.

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What happens to the AD curve when there is complete crowding out and government spending increases?

The AD curve does not shift, as any increase in government spending is fully offset by a decrease in private investment.

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Self-Regulating Economy

An economic system where markets are efficient and adjust automatically to maintain full employment and price stability without government intervention.

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Zero Crowding Out

A situation where government spending does not lead to any reduction in private investment. This is a rare scenario, but possible if the increased spending stimulates the economy sufficiently to offset any negative effects.

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What does crowding out mean?

Crowding out occurs when increased government spending leads to a decrease in private investment. This happens because the government borrows money to finance its spending, driving up interest rates, and making it more expensive for businesses to borrow.

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Why would a believer in a self-regulating economy be less likely to advocate for expansionary fiscal policy?

A believer in a self-regulating economy would be less likely to advocate for expansionary fiscal policy because they believe the market will naturally correct a recession. They believe government intervention is unnecessary and potentially harmful.

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How does crowding out affect the economy?

Crowding out can have a negative impact on the economy by reducing private investment and slowing down economic growth. It can also lead to higher interest rates, making it more expensive for consumers to borrow money.

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Study Notes

Balanced Budget

  • A balanced budget occurs when government expenditures equal tax revenues.

Budget Surplus

  • A budget surplus occurs when tax revenues exceed government expenditures.

Budget Deficit

  • A budget deficit occurs when government expenditures exceed tax revenues.

Fiscal Policy

  • Fiscal policy refers to changes in government expenditures and taxation to achieve economic goals.

Fiscal Policy Actions - Expansionary

  • Increasing government spending
  • Decreasing taxes

Fiscal Policy Actions - Contractionary

  • Decreasing government spending
  • Increasing taxes

Transfer Payment

  • A transfer payment is a flow of money from the government to households.

Crowding Out

  • Crowding out is a reduction in private spending due to increased government spending or a budget deficit.

Automatic Stabilizers

  • Automatic stabilizers are government spending and taxation programs that automatically adjust to offset economic fluctuations. An example is unemployment benefits.

Fiscal Policy Lags

  • Data lag: Time between an economic event and policymakers becoming aware of it.
  • Legislative lag: Time between when a policy is needed and when is passed and approved.
  • Effectiveness lag: Time between when a policy is implemented and when there is an observed impact on the economy.
  • Transmission lag: Time between policymakers implementing a policy measure and when the impact of the policy is felt on the economy.

Laffer Curve

  • Shows the relationship between tax rates and tax revenues.
  • Suggests that tax revenue can increase as marginal tax rates fall (below a certain threshold).

Progressive Tax

  • A progressive tax structure means those with higher incomes pay a higher percentage of their income in taxes.

Proportional Tax

  • A proportional tax structure means those with higher incomes pay the same percentage of their income in taxes.

Marginal Tax Rate

  • The tax rate applied to the next dollar of income earned.

Structural Deficit

  • The deficit that is present when the economy is at full employment.

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Description

This quiz covers essential concepts related to fiscal policy and budget management. Learn about balanced budgets, budget surpluses, deficits, and the various fiscal policy actions that governments can take. Test your understanding of automatic stabilizers and crowding out effects on the economy.

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