Topic 10
- Suppose that gifts were taxed at a rate of 10% for amounts up to $100,000 and 20% for anything over that amount. Would this tax be regressive or progressive?
This tax will be Progressive. This is because the rates on gifts increase with an increase in the value or amount (price) of the gift. Giving large gifts is associated with a large income and hence high tax rate.
- Do you think the typical time lag for fiscal policy is likely to be longer or shorter than the time lag for monetary policy? Explain your answer?
Fiscal policy usually has longer time lags than momentary policy. Near or during a recession, expansionary monetary policy can be undertaken through OMO (open market operation), can be conducted quickly (short time lag) because the FROMC (Federal Reserve Open Market Committee) conducts meetings six times annually. Besides, monetary policy becomes effective by interest rates which adjust reasonably quickly. Although, fiscal policy is undertaken through Congress acts, which require signing to be laws by the president. The negotiation of such laws usually takes months, even after the negations on the bills; it takes a longer time (more months) for tax cuts and spending programs to impact the macroeconomy.
- What is the difference between discretionary fiscal policy and automatic stabilizers?
Discretionary fiscal policy is enacted through Congress, while automatic stabilizer occurs with no necessary legislative actions.
Discretionary fiscal policy is exercised deliberately by the government during events of inflation or unemployment problems. In contrast, automatic stabilizers are not exercised deliberately by the government during events of inflation or issues of unemployment and thus occur automatically.
Discretionary fiscal policy involves establishments of policy objectives (legislative actions) to taxes and government expenditures to solve the problems of inflation or unemployment. In contrast, automatic stabilizers involves taxes and government expenditures changes or adjustments automatically without any deliberate legislative actions.
- In a booming economy, is the federal government more likely to run surpluses or deficits? What are the various factors at play? Be careful here… think economically and not what the political environment would be in the United States.
In a booming economy, the federal government would run a surplus. This is because, at booming times, there is an increase in tax revenue collection since many people are employed; hence they pay their taxes (increase in employment and taxpaying). The results are that there is a decrease in unemployment, together with a reduction in the benefits accrued. The increase in demand for products and services leads to more employment for the firms to meet the high demand through high outputs. This, in turn, results in a reduction in rates of unemployment in America. In simple terms, this surplus will occur since the high-income amount will attract more tax revenue while the government expenditures are low to reduce inflation.
- Specify whether expansionary or contractionary fiscal policy would seem to be most appropriate in response to each of the situations below and sketch a diagram using aggregate demand and aggregate supply curves to illustrate your answer:
- A recession.
- A stock market collapse that hurts consumer and business confidence.
- Extremely rapid growth of exports.
- Rising inflation.
- A rise in the natural rate of unemployment.
- A rise in oil prices.
During the recession, it’s suitable for the expansion of fiscal policy since the fiscal policy expansion leads to either rise in government expenditure or tax reduction. For instance, fiscal policy expansion will raise the expenses of the government. This will lead to a surge in outputs and aggregate demand. An increase in output will raise the level of employment in the economy. This is since, to increase outputs, requires more workers. Therefore, fiscal policy expansion will lead to a shift in AD (aggregate demand) to the right.
Stock market collapse harms both business and consumers confidence. These will result in a decrease in AD (aggregate demand). For the stimulation of demand, the government will undertake the expansion of fiscal policy through the increase of government expenditures. This will give rise to the AD (aggregate demand) curve shifting to the right.
Extremely rapid growth of exports will raise the AD (aggregate demand). This will raise prices, causing inflation. In this scenario, the government will increase taxes through the contraction of fiscal policy. Raising taxes will lead to a reduction in the purchasing power of individuals and also reduces AD (aggregate demand). This action will help counter inflation. Therefore contraction of fiscal policy will cause the AD (aggregate demand) to shift inwards or to the left.
Rising inflation will cause the government to raise taxes through the contraction of fiscal policy. The rise in taxes will reduce the purchasing powers of individuals, along with decreasing the AD (aggregate demand). This action will help in combating inflation. Therefore, fiscal policy contraction will cause the AD (aggregate demand) curve to shift to the left or inwards.
A rise in the natural rate of unemployment, in the short run, expansionary fiscal policy increases AD together with employment. Still, it not has any long-run effect on the unemployment rate. The reason behind this argument is that despite an economy having no demand deficit and operation is at full capacity; there will be some unemployment levels caused by factors from the supply side.
A rise in oil price can only occur when AS (aggregate supply) curve moves to the left, which will result in a decrease in quantity. For the stimulation of equilibrium quantity requires the application of expansionary fiscal policy, which causes a shift to the right for the AD (aggregate demand) curve. This action will lead the equilibrium quantity to return to its original level with the rise in prices.
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