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Chapter 13: Q. 13 (page 297)

Assume that the Ricardian equivalence theorem is not relevant. Explain why an income-tax-rate cut should affect short-run equilibrium real GDP.

Short Answer

Expert verified

As a result of changes in autonomous spending, the equilibrium real GDP is less stable.

Step by step solution

01

Introduction 

The given is that the Ricardian equivalence theorem is not relevant

The objective is to determine why an income tax rate cut affect short term equilibrium

02

Explanation 

A reduction in the income tax rate should have an influence on short-run equilibrium real GDP because it has an immediate effect on consumption, and consumption increases directly affect short-run equilibrium.

The tax system's automatic stabilizer properties, on the other hand, are dwindling. As a result of changes in autonomous spending, the equilibrium real GDP is less stable.

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Most popular questions from this chapter

If a government agency decided to fund the construction of a private hospital in an area in which other private hospitals already are just breaking even, why might one of the other private hospitals cancel plans to expand the size of its facility?

Suppose that Congress enacts a lump-sum tax cut of $750 billion. The marginal propensity to consume is equal to 0.75. Assuming that Ricardian equivalence holds true, what is the effect on equilibrium real GDP? On saving?

Suppose that Congress and the president decide that the nation's economic performance is weakening and that the government should "do something" about the situation. They make no tax changes but do enact new laws increasing government spending on a variety of programs.

a. Prior to the congressional and presidential action, careful studies by government economists indicated that the Keynesian multiplier effect of a rise in government expenditures on equilibrium real GDP per year is equal to 3. In the 12 months since the increase in government spending, however, it has become clear that the actual ultimate effect on real GDP will be less than half of that amount. What factors might account for this?

b. Another year and a half elapses following passage of the government spending boost. The government has undertaken no additional policy actions, nor have there been any other events of significance. Nevertheless, by the end of the second year, real GDP has returned to its original level, and the price level has increased sharply, Provide a possible explanation for this outcome.

Assume that MPC = 45when answering the following questions.

a. If government expenditures rise by \( 1 billion, by how much will the aggregate expenditure curve shift upward?

b. If taxes rise by \) 1 billion, by how much will the aggregate expenditure curve shift downward?

c. If both taxes and government expenditures rise by $ 1 billion, by how much will the aggregate expenditure curve shift? What will happen to the equilibrium level of real GDP?

d. How does your response to the second question in part (c) change if MPC = 34? If MPC =12?

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?
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