Download ECN 111 PRINCIPLES OF MACROECONOMICS SOLUTIONS TO

ECN 111
PRINCIPLES OF MACROECONOMICS
SOLUTIONS TO CHAPTER 16 PRACTICE PROBLEMS
1.
(a) The four categories that make up federal government expenditures (outflows) are:
government purchases and defense spending (G); transfer payments (TR); interest
payments on the national debt (INT); and grants to state and local governments.
(b) Of these four categories, transfer payments is the largest category.
(c) The four categories that make up federal government income (inflows) are:
individual income taxes (T); excise and sales taxes; corporate income taxes (τ); and social
insurance taxes (like social security deductions).
2.
Examples of automatic stabilizers are unemployment insurance and income taxes.
Automatic stabilizers change tax receipts and government spending automatically as a
result of fluctuations in the business cycle. This occurs without discretionary actions on
the part of government. In the case of recession, they would change automatically to
stimulate spending in the economy. During a recession, employment declines and
government spending on unemployment insurance payments increases. This should raise
disposable income and consumer spending above what they would otherwise be. During
a recession, income tax receipts decline as income declines. This automatic decline in
income tax revenues keeps disposable income and consumer spending from falling as
much as they would without the automatic stabilizers.
3.
If policy makers think that the economy is overheating because aggregate demand is
growing faster than long-run aggregate supply, they have two options. The federal
government can either (1) increase taxes [T] or (2) decrease government purchases [G].
This strategy is called a “contractionary fiscal policy.” By increasing taxes or decreasing
G, the government is reducing aggregate demand. The result is that the AD curve gets
pulled back—it shifts down and to the left. Therefore, the AD curve does not shift as far
out as it would without policy, and the inflation rate ends up at a lower level than if there
had not been any discretionary fiscal policy used.
4.
Accurately timing fiscal policy may be more difficult to accomplish than accurately
timing monetary policy for two reasons. First, the time it takes to come to a decision is
much longer for fiscal policy because the decision making body is large and diverse. The
president and a majority of Congress have to agree upon fiscal policy changes.
Comparatively, the body that decides monetary policy is the Federal Open Market
Committee, which has only twelve members. The smaller group has the ability to come
to decisions more quickly.
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Second, it can take longer to implement fiscal policy relative to monetary policy. If the
fiscal policy change is a government purchase, it takes time to plan the purchase, to
accept bids for the purchase, and to begin implementing the actual project. Monetary
policy is easy to implement. It begins with a simple, direct phone call to the trading desk
in New York to buy or sell Treasury securities.
5.
The federal government deficit is the annual change in the budget. A deficit occurs when
the federal government’s expenditures are greater than its tax revenues (outflows >
inflows). The deficit is a “flow” variable because it has a time dimension: the
government runs a deficit every month.
The federal government debt is the total value of all U.S. Treasury bonds outstanding.
The debt grows every year by the amount of the deficit. The debt is a stock variable: it is
the value of all U.S. bonds outstanding at a particular point in time.
Think about it this way: the national debt is the water in the bathtub. The federal deficit
is the water coming out of the faucet and filling up the bathtub with even more water
(debt).
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