INTRODUCTION TO ECONOMICS

Introduction To Economics



Introduction to Economics

Section A:

The open economy multiplier ------ its slope with a lump-sum tax system.

The answer for this statement is true. It is because in an open economy multiplier with a proportional tax. Since (1-c) is smaller than (1-c+ct) the multiplier is bigger when taxes are not proportional since the marginal propensity to withdraw is smaller. Therefore, proportional taxes help to stabilize the economy. The basic Keynesian cross model dealt with an economy that had lump sum taxes. The resulting multiplier was 1 1-b which implies a multiplier of 10 for a reasonable MPC of 0.9. This is an extremely unrealistically large multiplier. It means that a government can increase GDP by £10 merely by spending £1 (Adelman & Robinson , 1978: 56). The slope of the IS curve with a proportional tax system will be steeper than its slope with a lump-sum tax system because the multiplier is smaller with proportional tax than multiplier with a lump-sum tax.

By creating a surplus in the government ----- increase in actual investment.

The answer to this statement is false. As Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BoP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items. When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit.

Inflation is still costly even when it is fully anticipated.

The answer for this statement is true. Inflation is costly. When it is unanticipated, it arbitrarily benefits debtors and hurts creditors by decreasing the nominal value of outstanding debt. It discourages saving and investment by creating uncertainty about future prices. And, it forces businesses and individuals to spend time and resources predicting future prices and hedging against the risk of unexpected changes in the price level.

Inflation is also costly even when it is fully anticipated. Through its interaction with the tax system, it can increase tax burdens by artificially raising incomes and profits.1 For example, one study estimates that, because of this tax distortion, permanently lowering inflation by two percentage points could generate as much as an extra 1 percent of GDP per year (Feldstein). In addition, inflation causes firms to incur costs of changing prices. And, to the extent firms only infrequently change prices; inflation can distort relative prices and undermine the efficiency of the market's pricing mechanism.

The IS curve is downward sloping because ----- to dampen inflationary ...