Chapter 13: Q 1 Critical thinking question (page 293)
1. How does unemployment compensation function as an automatic stabilizer?
As a result, when pensioners have used up all of their Social Security benefits, they will not be able to raise equilibrium GDP in a one-shot boost.
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Determine whether each of the following is an example of an automatic fiscal stabilizer.
a. A federal agency must extend loans to businesses whenever an economic downturn begins.
b. As the economy heats up, the resulting increase in equilibrium real GDP per year immediately results in higher income tax payments, which dampen consumption spending somewhat.
c. As the economy starts to recover from a severe recession and more people go back to work, government-funded unemployment compensation payments begin to decline.
d. To stem an overheated economy, the president, using special powers granted by Congress, authorizes emergency impoundment of funds that Congress had previously authorized for spending on govemment programs.
Consider the accompanying diagram, in which the current short-run equilibrium is at point , and answer the questions that follow:
a. What type of gap exists at point ?
b. If the marginal propensity to consume equals , what change in government spending financed by borrowing from the private sector could eliminate the gap identified in part (a)? Explain.
If a government agency decided to fund the construction of a private hospital in an area in which other private hospitals already are just breaking even, why might one of the other private hospitals cancel plans to expand the size of its facility?
A government is currently operating with an annual budget deficit of billion. The government has determined that every billion reduction in the amount it borrows each year would reduce the market interest rate by percentage point. Furthermore, it has determined that every -percentage-point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to billion. The marginal propensity to consume is . Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes? (Hint: How much new private investment spending is induced by each billion decrease in government spending? )
2. Why do you suppose that many economists perceive a trade-off between short-term stabilization benefits of unemployment compensation and a contribution to a higher unemployment rate in the long run?
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