Macro Topic 3.

8
Fiscal Policy
Part 1 - Check Your Understanding- U se the information in the paragraph to answer the questions.
Assume that policymakers believed that the marginal propensity to consume (MPC) was 0.9.
Following the announcement in December 2008 that the U.S. economy had been in a recession
since December 2007, Congress and President Obama passed the A merican Recovery and
Reinvestment Act (ARRA) into law in February 2009. The ARRA cut taxes by $288 billion,
increased government spending by $275 billion, and increased transfer payments by $224
billion. Although not fully implemented, the majority of the government spending would take
place in 2010 and 2011.

1. Was the ARRA an example of discretionary fiscal policy or nondiscretionary fiscal policy?
Explain.

discretionary

2. Fiscal policy is sometimes criticized for having an implementation gap. Give evidence of an
implementation gap from the information in the paragraph.

The passage states that "majority of the government spending would take in 2010 and 2011
3. Calculate the maximum increase in GDP that could result from the tax cut. Show your work.

259.2 billion

4. Calculate the maximum increase in GDP that could result from the increase in government
spending. Show your work.

275 billion

5. Calculate the maximum increase in GDP that could result from the increase in government
transfers. Show your work.

201.6 billion

6. Based on your calculations, what is the maximum change in spending from the AARA? Show
your work.

787 billion
Part 2 – Bringing It All Together- For each of the following, assume aggregate output = $500 billion,
potential output = $750 billion, and the marginal propensity to consume (MPC) is 0.8
7. Draw a correctly labeled AS/AD model reflecting the current state
of the economy. Label the price level, P L1.

8. What is the least amount of government spending that could

achieve full employment? Show your work.

50 billion

9. Show the result of the government spending on the graph. Label

the new price level, P L2.

10. Assume instead that the government takes no action in response to this output gap and allows
the economy to self-adjust. Would the result be a price level at P L2? Why or why not?
It would not be at PL2

11. What are the benefits of allowing the economy to self-adjust?

Imbalances would not need corrections and the free market would be able to control the prices.

12. What are the costs of allowing the economy to self-adjust?

Unemployment and economic imbalance can occur.

13. What are the benefits of implementing fiscal policy to stabilize the economy?

It helps reduce unemployment and helps economic growth during recession.

14. What are the costs of implementing fiscal policy to stabilize the economy?

It can possibly cause inflation and increased government debt.

Part 3 – Putting It Together- Identify whether the following are most likely examples of discretionary
fiscal policy or non-discretionary fiscal policy (automatic stabilizers).

Situation Discretionary Non-discretionary

1. In 2009, Congress passes “Cash for Clunkers”
law offering incentives to buy new cars !!

2. The number of people who received

unemployment benefits increased by over 8 !!
million in 2009 from 2007
3. In 2018, Congress lowered the top marginal tax !!
rate from 39.6 to 37%
4. From 2013-2018, income-based transfer
!!
payments decreased
5. From 2008 to 2009 federal income tax revenue
!!
fell by over $200 billion
6. In 2009 Congress expanded Medicaid, TANF, !!
and SNAP, allowing more people to qualify