1. Describe the impact of inflationary and recessionary gaps p.233 and the lump sum tax of $15 billion with a MPC of 3/5 p. 231 on the domestic economy.

2. Complete # 2, 6, and 9 of Problems at the end of the chapter 11, p. 239.

3. Describe the difference between the actual & cyclical budget deficits with Table 13.1, p. 174.

4. Discuss and evaluate the five criticisms of fiscal policy, p. 276.

5. Evaluate the four substantive issues regarding the public debt, p. 281.

I { 2310f446 > 2 Aa Applying the Extended AD-AS Model LO17.2 Apply the extended (short-run/long-run) AD-AS model to Inflation, recessions, and economic growth. The extended AD-AS model helps clarify the long-run aspects of demand-pull inflation, cost-push inflation, and recession. Demand-Pull Inflation in the Extended AD-AS Model Recall that demand-pull inflation occurs when an increase in aggregate demand pulls up the price level. Earlier, we depicted this inflation by shifting an aggregate demand curve rightward along a stable aggregate supply curve (see Figure 12.8). In our extended AD-AS model. an increase in the price level that is associated with GDP exceeding the full employment level eventually leads to an increase in nominal wages and thus a leftward shift of the short-run aggregate supply curve. In Figure 17.3, we initially suppose the price level is P} at the intersection of aggregate demand curve AD,, short-run supply curve AS, and long-run aggregate supply curve ASy r. The economy is achieving its full-employment real output Qr at point a. FIGURE 17.3 Demand-pull inflation In the extended AD-AS model. An increase in aggregate demand from AD; to AD;, drives up the price level and increases real output in the short run. But in the long run, nominal wages rise and the short-run aggregate supply curve shifts leftward, as from AS; to AS,. Real output then returns to its prior level, and the price level rises even more. In this scenario, the economy moves from a to b and then eventually to c. { 2330f446 > 2 Aa The Long-Run Phillips Curve LO17.4 Explain why there is no long-run trade-off between inflation and unemployment. The overall set of data points in Figure 17.10 supports our third generalization relating to the inflation-unemployment relationship: There is no apparent /ong-run trade-off between inflation and unemployment. Economists point out that when decades (as opposed to a few years) are considered, any rate of inflation is consistent with the natural rate of unemployment. We know from @ Chapter 9 that the natural rate of unemployment is the unemployment rate that occurs when cyclical unemployment is zero; it is the full-employment rate, or the rate of unemployment when the economy achieves its potential output. Why is there a short-run inflation-unemployment trade-off but not a long-run trade-off? Figure 17.11 provides an answer. FIGURE 17.11 The long-run vertical Phillips Curve. Increases in aggregate demand beyond thase consistent with full-employment output may temporarily boost profits, output, and employment (as from a; to by). But nominal wages eventually will catch up so as to sustain real wages. When they do, profits will fall, negating the previous short-run stimulus to production and employment (the economy now moves from by to a;). Consequently, there is no trade-off between the rates of inflation and unemployment in the long run; that is, the long-run Phillips Curve is roughly a vertical line at the economy's natural rate of unemployment. { 2390f446 > PROBLEMS e 1. Use the nearby figure to answer the following questions. Assume that the economy initially is operating at price level 120 and real output level $870. This output level is the economy's potential (full-employment) level of output. Next, suppose that the price level rises from 120 to 130. By how much will real output increase in the short run? In the long run? Instead, now assume that the price level drops from 120 to 110. Assuming flexible product and resource prices, by how much will real output fall in the short run? In the long run? What is the long-run level of output at each of the three price levels shown? LO17.1 AS, AS, 130 _ AS, g s 120 o Lo = 10 { 1740of446 > 2 Aa Built-In Stability LO13.2 Explain how built-in stabilizers moderate business cycles. Tax Collections and the Business Cycle Under normal circumstances, government tax revenues change automatically over the course of the business cycle in ways that stabilize the economy. This automatic response, or built-in stability, constitutes what is commonly referred to as nondiscretionary (or \"passive\" or \"automatic\") budgetary policy. We did not include this built-in stability in the discussion about fiscal policy that we had in the last section because we implicitly assumed that the same amount of tax revenue was being collected at each level of GDP. But the actual U.S. tax system is such that net tax revenues vary directly with GDP. (Net taxes are tax revenues less transfers and subsidies. From here on, we will use \"taxes\" to mean \"net taxes.\") Virtually any tax will yield more tax revenue as GDP rises. In particular, personal income taxes have progressive rates and thus generate more-than-proportionate increases in tax revenues as GDP expands. Furthermore, as GDP rises and more goods and services are purchased, revenues from corporate income taxes and from sales taxes and excise taxes also increase. And, similarly, revenues from payroll taxes rise as economic expansion creates more jobs. Conversely, when GDP declines, tax receipts from all these sources also decline. Transfer payments (or \"negative taxes) behave in the opposite way from tax revenues. Unemployment compensation payments Page 271 and welfare payments decrease during economic expansion and increase during economic contraction. (281 of 446 > Aa Obstacles to Economic Development LO21.2 List the obstacles to economic development. The paths to economic development are essentially the same for developing countries and industrially advanced economies: . The DVCs must use their existing supplies of resources more efficiently. In other words, they must eliminate unemployment and underemployment, and they must combine labor and capital resources in a way that achieves lowest-cost production. They must also direct their scarce resources so that they will achieve allocationficiency. . The DVCs must expand the quantity and quality of their resources. By achieving greater supplies of raw materials, capital equipment, and productive labor, and by advancing their technological knowledge and human capital, DVCs can push their production possibilities curves outward. All DVCs are aware of these two paths to economic development. Why, then, have some of them traveled those paths while others have lagged far behind? The differences lie in the nations' physical, human, and socioeconomic environments. Natural Resources The distribution of natural resources among the DVCs is extremely uneven. Some DVCs have valuable deposits of bauxite, tin, copper, tungsten, nitrates, and petroleum, and they have used their natural resource endowments to achieve rapid growth. For example, several members of the Organization of Petroleum Exporting Countries (OPEC), including Kuwait, have used oil exports to grow their