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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

Label each of the following scenarios as an example of a recognition lag, administrative lag, or operational lag.

  1. To fight a recession, Congress has passed a bill to increase infrastructure spending鈥攂ut the legally required environmental-impact statement for each new project will take at least two years to complete before any building can begin.

  2. Distracted by a war that is going badly, politicians take no notice until inflation reaches 8 percent.

  3. Politicians recognize a sudden recession, but it takes many months of political deal making before they finally approve a stimulus bill.

  4. To fight a recession, the president orders federal agencies to get rid of petty regulations that burden private businesses鈥攂ut the federal agencies begin by spending a year developing a set of regulations on how to remove petty regulations.

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鈥檚 fiscal situation are true?

  1. The government has a non鈥揷yclically adjusted budget deficit of \(595 billion.

  2. The government has a non鈥揷yclically adjusted budget deficit of \)90 billion.

  3. The government has a non鈥揷yclically 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.

In January, the interest rate is 5 percent and firms borrow \(50 billion per month for investment projects. In February, the federal government doubles its monthly borrowing from \)25 billion to \(50 billion, driving the interest rate up to 7 percent. As a result, firms cut back their borrowing to only \)30 billion per month. Which of the following is true?

  1. There is no crowding-out effect because the government鈥檚 increase in borrowing exceeds firms鈥� decrease in borrowing.

  2. There is a crowding-out effect of \(20 billion.

  3. There is no crowding-out effect because both the government and firms are still borrowing a lot.

  4. There is a crowding-out effect of \)25 billion.

How do economists distinguish between the absolute and relative sizes of the public debt? Why is the distinction important? Distinguish between refinancing the debt and retiring the debt. How does an internally held public debt differ from an externally held public debt? Contrast the effects of retiring an internally held debt and retiring an externally held debt.

What are the government鈥檚 fiscal policy options for ending severe demand-pull inflation?
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