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Chapter 27: Problem 9

If, rather than being upward sloping, the short-run aggregate supply (SRAS) curve were a horizontal line at the current price level, what would be the effect on the size of the government purchases and tax multipliers? Briefly explain.

Short Answer

Expert verified
If the short-run aggregate supply (SRAS) curve were a horizontal line at the current price level, then both the government purchases and tax multipliers would be larger. This is because, when the SRAS curve is horizontal, changes in government purchases and taxes can cause larger changes in aggregate demand without any change in the price level.

Step by step solution

01

Understanding the Concept of Aggregate Supply

The aggregate supply curve shows the total quantity of output—real GDP—that firms will produce and sell at each price level. The short-run aggregate supply (SRAS) curve shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms. When the SRAS curve is upward sloping, it means that when the price level rises, the quantity of real GDP supplied also rises.
02

Understanding the Concept of SRAS as a Horizontal Line

When the SRAS curve is a horizontal line at the current price level, it means that changes in the price level do not affect the quantity of real GDP supplied by firms. In other words, firms are willing to supply the same amount of real GDP at any price level.
03

Calculating the effect on the Government Purchases

The government purchases multiplier is the change in aggregate demand that results from a change in government purchases. When the SRAS curve is horizontal, the government purchases multiplier is large because an increase in government purchases will lead to a larger increase in aggregate demand. This is because the level of output can increase without any increase in the price level.
04

Calculating the effect on the Tax Multipliers

The tax multiplier is the change in aggregate demand that results from a change in taxes. When the SRAS curve is horizontal, the tax multiplier is large in absolute value because a change in taxes will lead to a larger change in aggregate demand. Again, this is because any change in taxes can lead to an increase in output without any increase in price level.

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Most popular questions from this chapter

Briefly explain whether you agree with the following statements: "An expansionary fiscal policy involves an increase in government purchases or an increase in taxes. A contractionary fiscal policy involves a decrease in government purchases or a decrease in taxes."

What are the key differences between how we illustrate a contractionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

Suppose that at the same time that Congress and the president pursue an expansionary fiscal policy, the Federal Reserve pursues an expansionary monetary policy. How might an expansionary monetary policy affect the extent of crowding out in the short run?

A political columnist wrote the following: Today ... the main purpose [of governments issuing bonds] is to let craven politicians launch projects they know the public, at the moment, would rather not fully finance. The tab for these projects will not come due, probably, until after the politicians have long since departed for greener (excuse the expression) pastures. Do you agree with this commentator's explanation for why some government spending is financed through tax receipts and other government spending is financed through borrowing, by issuing bonds? Briefly explain.

Briefly explain whether each of the following is (1) an example of a discretionary fiscal policy, (2) an example of an automatic stabilizer, or (3) not an example of fiscal policy. a. The federal government increases spending on rebuilding the New Jersey Shore following a hurricane. b. The Federal Reserve sells Treasury securities. c. The total amount the federal government spends on unemployment insurance decreases during an expansion. d. The revenue the federal government collects from the individual income tax declines during a recession. e. The federal government changes the fuel efficiency requirements for new cars. f. Congress and the president enact a temporary cut in payroll taxes. g. During a recession, California voters approve additional spending on a statewide high-speed rail system.
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