Economics Answer Note #79

Question 1 Which of the following are examples of automatic stabilizers? Check all that apply. Corporate income taxes . The discount rate Personal income taxes Answer Automatic stabilizers refer to government policies or programs that help stabilize the economy without any additional action needed from policymakers. They work automatically in response to changes in economic conditions. Examples of automatic stabilizers include unemployment benefits, progressive income taxes, and changes in government spending. In relation to the options given, corporate income taxes and personal income taxes are considered automatic stabilizers. Corporate income taxes are taxes imposed on the profits of businesses, both domestic and foreign. These taxes are typically proportional to the company's profits and can act as an automatic stabilizer by adjusting to the economic conditions. In a recession, when businesses experience a decline in profits, they pay lower taxes, allowing them to retain more funds for investment and spending. This can help stimulate economic growth and reduce the impact of the recession. Personal income taxes, on the other hand, refer to taxes imposed on individuals' income, which includes wages, salaries, interest, dividends, and other sources of income. The progressive tax system, where individuals with higher incomes are taxed at a higher rate, acts as an automatic stabilizer. In times of economic downturn, individuals may experience a decrease in income, and with progressive taxation, they will pay fewer taxes, leaving them with more disposable income to spend and stimulate the economy. Question 2 Which of the following are arguments in favor of active stabilization policy by the government? Check all that apply. Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses. Changes in government purchases and taxation must be passed by both houses of Congress and signed by the president. Businesses make investment plans many months in advance. The current tax system acts as an automatic stabilizer. Answer Active stabilization policy by the government refers to the deliberate actions taken by the government to influence macroeconomic variables such as aggregate demand, inflation, and employment in order to stabilize the economy. In this response, we will discuss the various arguments in favor of active stabilization policy by the government. 1. Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses. One of the main arguments in favor of active stabilization policy by the government is that shifts in aggregate demand, which are key drivers of economic growth, are often influenced by consumer and business sentiment. Waves of pessimism or optimism can lead to fluctuations in consumer spending and business investment, which in turn can significantly impact the overall economic activity. By implementing active stabilization policies, the government can help mitigate these shifts and maintain a stable level of aggregate demand, thereby promoting economic stability and growth. 2. Changes in government purchases and taxation must be passed by both houses of Congress and signed by the president. Another argument in favor of active stabilization policy is that it allows the government to respond quickly to changes in the economy. Unlike monetary policy, which is controlled by the central bank and subject to certain limitations, fiscal policy can be implemented swiftly and effectively by the government. Through changes in government purchases and taxation, the government can influence aggregate demand and steer the economy towards stability. 3. Businesses make investment plans many months in advance. Active stabilization policies also help to address the issue of long-term planning by businesses. As businesses make investment plans many months in advance, they may be hesitant to invest during periods of economic uncertainty. By implementing active stabilization policies, the government can provide a more stable economic environment, thus encouraging businesses to make long-term investments and contribute to economic growth. 4. The current tax system acts as an automatic stabilizer. Lastly, the argument for active stabilization policy is strengthened by the role of the current tax system as an automatic stabilizer. During times of economic downturn, the government can use tax policies to provide fiscal stimulus and support aggregate demand. For example, during a recession, the government can implement tax cuts or provide tax credits to individuals and businesses, which can help boost consumer spending and business investment, respectively. In conclusion, active stabilization policy by the government has several arguments in its favor, including its ability to mitigate shifts in aggregate demand, respond quickly to changes in the economy, support long-term planning by businesses, and use the current tax system as an automatic stabilizer. These arguments highlight the importance of active stabilization policies in promoting economic stability and growth in an ever-changing economy. Question 3 1) Alice is willing to spend $30 on a pair of jeans, and has a coupon for $10 off she found online. She selects and purchases a $35 pair of jeans, pre-discount. Alice's surplus = ? 2) Jeff finds some steaks for $16 for which he would have been willing to pay $20. The butcher notices the meat is near the expiration date and gives him an extra 75% off. Jeff's surplus = ? 3) Nicole has in her possession a hockey puck from the 2010 Winter Olympic Games and sells it on eBay. She will only sell the puck if the winning bid is greater than or equal to $500. After bidding closes, the last bid stands at $500 Nicole's surplus = ? 4) Claire is trying to sell her used calculus textbook online. She asks for $150 or best offer and is willing to sell for anything over $100. She is able to sell it for $125 Claire's surplus = ? 5) Roy is willing to pay $2.50 for a sports drink. He notices the price is $2.79 and chooses not to purchase a sports drink. Roy's surplus = ? Answer The surplus in this scenario can be calculated by deducting the total amount she spent on the jeans ($35) from her initial budget ($30). However, we also need to take into consideration the $10 discount she received from the coupon. This would mean that her total spent amount would be $25. Therefore, Alice's surplus is $5. 2) Jeff finds some steaks for $16 for which he would have been willing to pay $20. The butcher notices the meat is near the expiration date and gives him an extra 75% off. Jeff's surplus = ? To calculate Jeff's surplus, we first need to determine the amount he actually paid for the steaks. Since the butcher gave him an extra 75% off, Jeff would only have to pay 25% of the original price ($16). This would mean that he paid $4 for the steaks. His initial willingness to pay was $20, but he only spent $4, which means his surplus is $16. 3) Nicole has in her possession a hockey puck from the 2010 Winter Olympic Games and sells it on eBay. She will only sell the puck if the winning bid is greater than or equal to $500. After bidding closes, the last bid stands at $500 Nicole's surplus = ? Since the last bid stands at exactly $500, this means that Nicole's surplus is $0. She was only willing to sell the puck for a minimum of $500 and she received the exact amount, leaving her with no surplus. 4) Claire is trying to sell her used calculus textbook online. She asks for $150 or best offer and is willing to sell for anything over $100. She is able to sell it for $125 Claire's surplus = ? In this case, Claire's surplus is calculated by deducting the actual amount she sold the textbook for ($125) from her minimum acceptable price ($100). This would mean that her surplus is $25. 5) Roy is willing to pay $2.50 for a sports drink. He notices the price is $2.79 and chooses not to purchase a sports drink. Roy's surplus = ? Roy's surplus in this scenario would be $0. Since he was not willing to pay the price of $2.79, he did not make a purchase and his surplus remains at $0. Question 4 In the Keynesian-cross model, if the MPC equals 0.75, then a $2 billion increase in government spending increases planned expenditures by ______ and increases the equilibrium level of income by ______. Answer In the Keynesian-cross model, the marginal propensity to consume (MPC) represents the fraction of an additional dollar of income that is spent, rather than saved. This means that in this model, a $2 billion increase in government spending will lead to an increase in planned expenditures by $1.5 billion (0.75 x $2 billion). Furthermore, this increase in planned expenditures will lead to a multiplier effect on the equilibrium level of income. The multiplier effect refers to the change in total income that results from a change in autonomous expenditure, such as government spending. In the Keynesian-cross model, the multiplier effect is represented by the formula 1/(1MPC). This means that a $2 billion increase in government spending will lead to a $6.67 billion increase in the equilibrium level of income (1/(1-0.75) x $1.5 billion). To further illustrate this, let us consider the following example: Assuming the MPC is 0.75 and the equilibrium level of income is $10 billion, then an increase in government spending of $2 billion would lead to a total planned expenditure of $11.5 billion ($10 billion + $1.5 billion). This increase in planned expenditure would then lead to a multiplier effect of 4 (1/(1-0.75)). This means that the equilibrium level of income would increase to $13.5 billion ($10 billion + $3.5 billion). To summarize, in the Keynesian-cross model, if the MPC equals 0.75, then a $2 billion increase in government spending will increase planned expenditures by $1.5 billion and increase the equilibrium level of income by $6.67 billion. Question 5 A large corporation that runs nursing homes estimates that changes to Medicare will result in lower payments by Medicare to nursing homes for short-term stays by patients that require therapy or care upon leaving hospitals. Assume the corporation is considering expanding the number of "beds" it offers at its nursing homes. Given the changes to Medicare, if the marginal benefit of offering an additional bed is $7000 and the marginal cost is $4000 per bed, then the corporation should or should not offer additional beds. Answer In light of the expected changes to Medicare, it is important for the corporation to carefully evaluate its decision to expand the number of beds offered at its nursing homes. While the marginal benefit of offering an additional bed is $7000, it is crucial to compare it with the marginal cost of $4000 per bed in order to make an informed decision.