1) When there is an interval between when the fiscal policy changes and correspo
ID: 1105463 • Letter: 1
Question
1) When there is an interval between when the fiscal policy changes and corresponding changes in aggregate spending, we have a(n)
A. aggregate time lag.
B. action time lag.
C. effect time lag.
D. recognition time lag.
2) Discretionary fiscal policy
A. can be very effective in influencing real GDP during abnormal times, such as when a nation is at war.
B. may reassure investors and consumers that the federal government will be able to avert a major economic downturn.
C. is not very effective in influencing real GDP during normal times because of time lags.
D. all of the above
3) Suppose that the economy is depicted by the following relationship:
Expenditures = C + I + G + X
where: C = $100 + 0.80(Y-T)
G = $600
T = $600
I = $200
X = $50
The economy is in equilibrium at a level of real GDP or income of $_______.
Now suppose that the government decided to increase taxes by $100.
What is the new equilibrium level of GDP or income?
4) In Country X, the government simultaneously increases its expenditures by $100 billion and increases taxes by $100 billion.
If the MPS is equal to 0.4, the government's action ________ real GDP by ________.
A. decreases; $250 billion
B. increases; $100 billion
C. has no effect on; $0
D. increases; $250 billion
Explanation / Answer
(1) (C)
This external time lag is also called Responsiveness or Effectiveness lag.
(2) (D)
All the options are correct. Discretionary fiscal policy is not too helpful during normal economic periods.
(3)
(a) Y = 100 + 0.8(Y - 600) + 200 + 600 + 50
Y = 950 + 0.8Y - 480
0.2Y = 470
Y = 2,350
(b) When T rises by 100, T = 600 + 100 = 700
Y = 100 + 0.8(Y - 700) + 200 + 600 + 50
Y = 950 + 0.8Y - 560
0.2Y = 390
Y = 1,950
(4) (B)
Spending multiplier = 1 / MPS = 1 / 0.4 = 2.5
As G increases by $100 billion, Real GDP increases by ($100 billion x 2.5) = $250 billion.
Tax multiplier = - (1 - MPS) / MPS = - (1 - 0.4) / 0.4 = - 0.6 / 0.4 = - 1.5
As T increases by $100 billion, Real GDP decreases by ($100 billion x 1.5) = $150 billion.
Net increase in Real GDP = $(250 - 150) Billion = $100 Billion
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