Fiscal Policy

1. How could the existence of unemployment benefits or other transfer programs reduce the

severity of an economic contraction?

2. Refer to the figure below and answer the following questions.

2a. Given that the economy has moved from A to B what would be the appropriate

fiscal policy to achieve potential GDP and why?

2b. If fiscal policy is successful at moving the economy from point B to equilibrium at

potential GDP, which of the following will occur and why?

3. Identify each of the following as (i) part of an expansionary fiscal policy, (ii) part of a

contractionary fiscal policy, or (iii) not part of fiscal policy.

3a.  The personal income tax rate is lowered.

3b.  The government increases spending on defence due to a change in spending

priorities.

3c.  The company income tax rate is lowered.

3d.  The State of New South Wales builds a new tollway in an attempt to expand

employment and ease traffic congestion.

4. Using the following table, answer the following questions. The numbers in the table are in

billions of dollars.

Real GDP Consumption Planned

Investment

Government

Purchases

500 400 100 150 -50

600 450 100 150 -50

700 500 100 150 -50

800 550 100 150 -50

4a.  What is the equilibrium level of real GDP?

4b.  What is the MPC?

Net Exports

4c.  If investment spending declines by 50, what will happen to equilibrium GDP?

5. Suppose the current equilibrium GDP for a country is $14.5 trillion and potential GDP is

$14.3 trillion. Will decreasing government purchases by $200 billion or raising taxes by

$200 billion restore the economy to potential GDP? Briefly explain why.