week 7

Question 1

The four-sector model

Answer 1

• includes household consumption (Cd)
• firms: planned investment (Ip)
• government sector: government spending (G)
• export (X)

PAE = Cd + Ip + G + X

Question 2

income-expenditure multiplier

Answer 2

• change in exogenous spending directly affects Y

- higher Y induces further increases in spending, leading to an output higher than increase in spending that started it

Question 3

alternative equilibrium condition in the four sector model

Answer 3

• for equilibrium to occur, any injections of expenditure into the economy are exactly matched by withdrawal of expenditure

Question 4

fiscal policy

Answer 4

• the use of the commonwealth budget to achieve macroeconomic objectives
• designed and implemented to achieve a pre-determined level of output in the economy
• can be automatic / discretionary

Question 5

automatic fiscal policy

Answer 5

• is a fiscal policy action triggered by the state of the economy with no government action

Question 6

discretionary fiscal policy

Answer 6

• is a policy action that is initiatted by an act of parliament

Question 7

discretionary fiscal policy - changes in G

Answer 7

• intuition: as government purchases of goods and services is a component of PAE, deficiencies in PAE can be compensated with changes in g.spending
• g.spending is exogenous, therefore changes in G will shift the PAE line
• contractionary gap
• > increase in G shift PAE up and increase level of actual output
• expansionary gap
• > decrease in G will shift PAE down and decrease level of actual output

Question 8

discretionary fiscal policy - changes in T

Answer 8

• discretionary fiscal policy can also the take form of changes to the level and types of taxes and transfer payments in the economy
• payments are not for the purchases of current goods and services, and are not part of G.
• > therefore these changes do not affect PAE directly
• affect level of disposable income (Y-T)

Question 9

three qualifications of fiscal policy

Answer 9

• fiscal policy and the supply side
• sustainability ( deficits)
• inflexible

Question 10

• supply-side effects of FP

Answer 10

• affects employment, GDP and aggregate supply
• G spending on public capital (e.g roads) play a role in the growth of potential gdp
• taxes and transfer payments play a role in affecting incentives and therefore economic behaviour

Question 11

fiscal sustainability

Answer 11

expansion -> deficits
- politicians can send this debt to future generations

• rules need to be created to prevent this

Question 12

FP is relatively inflexible

Answer 12

• lags
• recognition lag
• > time it takes to figure out that fiscal policy needs to start
• law making lag
• > time it takes to pass laws
• impact lag
• > time it takes from passing a tax or spending change to its effect

Question 13

FP and distribution of income

Answer 13

• manipulating tax manipulates distribution of income