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Chapter 13: Q 1 Critical thinking question (page 293)

1. How does unemployment compensation function as an automatic stabilizer?

Short Answer

Expert verified

As a result, when pensioners have used up all of their Social Security benefits, they will not be able to raise equilibrium GDP in a one-shot boost.

Step by step solution

01

Introduction

The given is the context about the unemployment compensation function

The objective is to determine how does the function act as an automatic stabilizer

02

Step 1

The existing Social Security system permits pensioners to be compensated from current workers' pockets. If every dollar they receive is spent solely on consumption, it contributes to GDP.

However, because that dollar is paid by workers as payroll taxes, the GDP shrinks at the same time. As a result, the net effect on GDP is approaching zero dollars.

03

Step 2 

As a result, when pensioners have used up all of their Social Security benefits, they will be unable to raise equilibrium GDP in a single shot. However, because the reduction in GDP and the addition in GDP are originally equal, the multiplier impact may be the same.

However, if income is compounded over numerous rounds or periods, equilibrium GDP may rise.

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Most popular questions from this chapter

Explain how time lags in discretionary fiscal policy making could thwart the efforts of Congress and the president to stabilize real GDP in the face of an economic downturn. Is it possible that these time lags could actually cause the discretionary fiscal policy to destabilize real GDP?

Suppose that Congress enacts a significant tax cut with the expectation that this action will stimulate aggregate demand and push up real GDP in the short run. In fact, however, neither real GDP nor the price level changes significantly as a result of the tax cut. What might account for this outcome?

Every 1-percentage-point increase in the marginal income tax rate induces some workers to supply less labour, which cuts real GDP by \( 0.2 trillion. At the same time, each 1-percentage point increase in the marginal income tax rate causes spendable income to drop, which induces some workers to supply labour that yields \) 0.1 trillion more in real GDP. Is the net outcome consistent with the supply-side theory? Why?

Determine whether each of the following is an example of a situation in which there is indirect crowding out resulting from an expansionary fiscal policy action.

a. The government provides a subsidy to help keep an existing firm operating, even though a group of investors otherwise would have provided a cash infusion that would have kept the company in business.

b. The government reduces its taxes without decreasing its expenditures. To cover the resulting budget deficit, it borrows more funds from the private sector, thereby pushing up the market interest rate and discouraging private planned investment spending.

c. Government expenditures fund construction of a high-rise office building on a plot of land where a private company otherwise would have constructed an essentially identical building.

In May and June of 2008, the federal government issued one-time tax rebates - checks returning a small portion of taxes previously paid to millions of U.S residents, and U.S. real disposable income temporarily jumped by nearly $500 billion. Household real consumption spending did not increase in response to the short-lived increase in real disposable income. Explain how the logic of the permanent income hypothesis might help to account for this apparent non relationship between real consumption and real disposable income in the late spring of 2008.
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