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Chapter 13: Q1. (page 283)

Which of the following would help a government reduce an inflationary output gap?

  1. Raising taxes

  2. Lowering taxes

  3. Increasing government spending

  4. Decreasing government spending

Short Answer

Expert verified

Option (a): raising taxes; option (d): decreasing government spending

Step by step solution

01

Explanation for correct options

During an inflationary expenditure gap, the total spending hikes due to a pull in prices by heavy consumer demand. The demand has to be cut down to reduce the inflationary gap.The economy's aggregate demand can be reduced either by increasing the taxes or decreasing government spending or both simultaneously.

Higher taxes will minimize the disposable income of consumers, and the consumption expenditure will decline, which will ultimately reduce the aggregate demand or expenditure in the economy. The inflationary output gap will be minimized.

Decreased government spending will directly shrink the economy's aggregate expenditure. As aggregate expenditure declines, the price level will also decline, which reduces the inflationary gap.

02

Explanation for incorrect options

A lowering of taxes will enhance the consumption capacity of households.As a result, private consumption will be pushed forward, increasing the aggregate expenditure further, widening the inflationary gap.On the other hand, increasing government spending will lift the aggregate expenditure resulting in a multiplied inflationary output gap.

Therefore options (b) and (c) are incorrect.

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Most popular questions from this chapter

Assume that a hypothetical economy with an MPC of .8 is experiencing a severe recession. By how much would government spending have to rise to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve the same increase in aggregate demand? Determine one possible combination of government spending increases and tax decreases that would accomplish the same goal.

What do economists mean when they say Social Security and Medicare are “pay-as-you-go” plans? What are the Social Security and Medicare trust funds, and how long will they have money left in them? What is the key long-run problem of both Social Security and Medicare? To fix the problem, do you favor increasing taxes or do you prefer reducing benefits?

(For students who were assigned Chapter 11) Assume that, without taxes, the consumption schedule for an economy is as shown below:

GDP, Billions

Consumption, Billions
\(100120
200200
300280
400360
500440
600520
700600

  1. Graph this consumption schedule. What is the size of the MPC?

  2. Assume that a lump-sum (regressive) tax of \)10 billion is imposed at all levels of GDP. Calculate the tax rate at each level of GDP. Graph the resulting consumption schedule and compare the MPC and the multiplier with those of the pretax consumption schedule.

  3. Now suppose a proportional tax with a 10 percent tax rate is imposed instead of the regressive tax. Calculate and graph the new consumption schedule, and calculate the MPC and the multiplier.

  4. Finally, impose a progressive tax such that the tax rate is 0 percent when GDP is \(100, 5 percent at \)200, 10 percent at \(300, 15 percent at \)400, and so forth. Determine and graph the new consumption schedule, noting the effect of this tax system on the MPC and the multiplier.

  5. Use a graph similar to Figure 13.3 to show why proportional and progressive taxes contribute to greater economic stability, while a regressive tax does not.

Last year, while a hypothetical economy was in a recession, government spending was \(595 billion, and government revenue was \)505 billion. Economists estimate that if the economy had been at its full employment level of GDP last year, government spending would have been \(555 billion and government revenue would have been \)550 billion. Which of the following statements about this government’s fiscal situation are true?

  1. The government has a non–cyclically adjusted budget deficit of \(595 billion.

  2. The government has a non–cyclically adjusted budget deficit of \)90 billion.

  3. The government has a non–cyclically adjusted budget surplus of \(90 billion.

  4. The government has a cyclically adjusted budget deficit of \)555 billion.

  5. The government has a cyclically adjusted budget deficit of \(5 billion.

  6. The government has a cyclically adjusted budget surplus of \)5 billion.

Use the aggregate expenditures model to show how government fiscal policy could eliminate either a recessionary expenditure gap or an inflationary expenditure gap (Figure 11.7). Explain how equal-size increases in G and T could eliminate a recessionary gap and how equal-size decreases in G and T could eliminate an inflationary gap.
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