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Chapter 13: Q. 13 (page 297)

Assume that the Ricardian equivalence theorem is not relevant. Explain why an income-tax-rate cut should affect short-run equilibrium real GDP.

Short Answer

Expert verified

As a result of changes in autonomous spending, the equilibrium real GDP is less stable.

Step by step solution

01

Introduction

The given is that the Ricardian equivalence theorem is not relevant

The objective is to determine why an income tax rate cut affect short term equilibrium

02

Explanation

A reduction in the income tax rate should have an influence on short-run equilibrium real GDP because it has an immediate effect on consumption, and consumption increases directly affect short-run equilibrium.

The tax system's automatic stabilizer properties, on the other hand, are dwindling. As a result of changes in autonomous spending, the equilibrium real GDP is less stable.

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Most popular questions from this chapter

Currently, a government's budget is balanced. The marginal propensity to consume is $\(0.80$ . The government has determined that each additional $\) 10$ billion it borrows to finance a budget deficit pushes up the market interest rate by role="math" localid="1651613391961" $0.1$ percentage point. It has also determined that every role="math" localid="1651613378175" $0.1$ -percentage point change in the market interest rate generates a change in planned investment expenditures equal to $\(2$ billion. Finally, the government knows that to close a recessionary gap and take into account the resulting change in the price level, it must generate a net rightward shift in the aggregate demand curve equal to $\) 200$ billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase its expenditures? (Hint: How much private investment spending will each $$ 10$ billion increase in government spending crowd out?)

Explain how time lags in discretionary fiscal policy making could thwart the efforts of Congress and the president to stabilize real GDP in the face of an economic downturn. Is it possible that these time lags could actually cause the discretionary fiscal policy to destabilize real GDP?

A government is currently operating with an annual budget deficit of $\(40$ billion. The government has determined that every $\) 10$ billion reduction in the amount it borrows each year would reduce the market interest rate by $0.1$ percentage point. Furthermore, it has determined that every $0.1$ -percentage-point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to $\(5$ billion. The marginal propensity to consume is $0.75$ . Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to $\) 40$ 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 $$ 10$ billion decrease in government spending? )

Determine whether each of the following is an example of a situation in which a direct expenditure offset to fiscal policy occurs.

a. In an effort to help rejuvenate the nation's railroad system, a new government agency buys unused track, locomotives, and passenger and freight cars, many of which private companies would otherwise have purchased and put into regular use.

b. The government increases its expenditures without raising taxes. To cover the resulting budget deficit, it borrows more funds from the private sector, thereby pushing up the market interest rate and discouraging private planned investment spending.

c. The government finances the construction of a classical music museum that otherwise would never have received private funding.

Determine whether each of the following is an example of discretionary fiscal policy action.

a. A recession occurs, and government-funded unemployment compensation is paid to laid-off workers.

b. Congress votes to fund a new jobs program designed to pat unemployed workers to work.

c. The Federal Reserve decides to reduce the quantity of money in circulation in an effort to slow inflation.

d. Under powers authorized by an act of Congress, the president decides to authorize an emergency release of funds for spending programs intended to head off economic crises.

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