Economics (Irwin Economics)
21st Edition
ISBN: 9781259723223
Author: Campbell R. McConnell, Stanley L. Brue, Sean Masaki Flynn Dr.
Publisher: McGraw-Hill Education
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Question
Chapter 33, Problem 7P
To determine
Crowding out.
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Suppose that the investment demand curve in a certain economy is such that investment declines by $110 billion for every 1 percentage point increase in the real interest rate. Also, suppose that the investment demand curve shifts rightward by $170 billion at each real interest rate for every 1 percentage point increase in the expected rate of return from investment. If stimulus spending (an expansionary fiscal policy) by government increases the real interest rate by 2 percentage points, but also raises the expected rate of return on investment by 1 percentage point, how much investment, if any, will be crowded out?
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Suppose that the investment demand curve in a certain economy is such that investment declines by $110 billion for every 1
percentage point increase in the real interest rate. Also, suppose that the investment demand curve shifts rightward by $190 billion at
each real interest rate for every 1 percentage point increase in the expected rate of return from investment. If stimulus spending (an
expansionary fiscal policy) by government increases the real interest rate by 2 percentage points, but also raises the expected rate of
return on investment by 1 percentage point, how much investment, if any, will be crowded out?
Instructions: Enter your answer as a whole number.
billion
%24
Is is possible for federal investment to have a negative rate of return?
Yes, if the spending results in a strong crowding-out effect or if state and local governments substitute towards federal investment by reducing stateand local investment. Either would potentially reduce future productivity and output (GDP), resulting in a negative return.
Yes, if the spending results in a weak crowding-out effect or if state and local investments complement the increase in federal investment by. Either would potentially reduce future productivity and output (GDP) and hence result in a negative return.
No. At worst, federal investment can have no future return as the expenditure offered some form of service (ex. jobs training) or useful infrastructure (ex. highways).
No. If in the future there were a negative return, the federal government would increase expenditures again to offset it.
Chapter 33 Solutions
Economics (Irwin Economics)
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Similar questions
- What is the main reason for employing contractionary fiscal policy in a time of strong economic growth?arrow_forwardSpecify whether expansionary or contractionary fiscal policy would seem to be most appropriate in response to each of the situations below and sketch a diagram using aggregate demand and aggregate supply curves to illustrate your answer: A recession. A stock market collapse that hurts consumer and business confidence. Extremely rapid growth of exports. Rising inflation. A rise in the natural rate of unemployment. A rise in oil prices.arrow_forward7. Examine whether the following items are built-in stabilizers or discretionary changes. (a)Unemployment benefits (b)Tax cuts (c)An increase in government spending on road work (d)Progressive tax systemarrow_forward
- Explain the effect of a discretionary cut in taxes of $50 billion on the economy when the economy's marginal propensity to consume is 0.9. How does this discretionary fiscal policy differ from a discretionary increase in government spending of $40 billion?arrow_forward1 As economies go into recession a) Government spending will decrease b) Tax revenue will decrease c) Budget deficits will decrease d) Unemployment rates will decrease 2 During a recession, which of the following would NOT be considered an automatic stabilizer? a) Decreased income tax revenues from falling incomes b) Decreased sales tax revenues from a falling amount of sales c) Increases in unemployment payments due to high unemployment rates d) An increase in government spending on infrastructure to stimulate the economy 3 Suppose a $100 billion increase in government spending has caused a total of $200 billion increase in spending. What is the marginal propensity to consume? a) MPC = 0.2 b) MPC = 0.5 c) MPC = 2.0 d) MPC = 5.0arrow_forward2. Show graphically that tax cuts are a less effective fiscal policy tool the greater the sensitivity of investment to interest rates.arrow_forward
- Assume there is a decrease in the aggregate demand, if expansionary fiscal policy is being used, the following action could be taken a. increase consumption by raising disposable income through cuts in personal taxes or payroll taxes b. increasing government spending by raising after-tax profits through cuts in business taxes c. increase government purchases through increased Federal Government spending on final goods and services and raising grants to state and local government to increase their expenditures on final goods and services d. All of the abovearrow_forwardSuppose that you are a member of the Council of Economic Advisers. The president has asked you to prepare a statement on the question, "What is the proper fiscal policy for the next 12 months?" Pre-pare such a statement, indicating (a) the current state of the economy (that is, the unemployment rate, growth in real income, and rate of inflation) and (b) your fiscal policy suggestions. Should the budget be in balance? Explain the reasoning behind your suggestions.arrow_forwardSuppose actual real GDP is $7.91 trillion, potential real GDP is $13.33 trillion, the marginal propensity to consume is 0.68, and that the government has a balanced budget. If we ignore price effects, by how many trillions of dollars should the government change its spending to fix the gap while keeping the federal budget balanced? (Round this to two digits after the decimal and enter this value as either a positive value or a negative value without the dollar sign.)arrow_forward
- Suppose that the economy is experiencing a recession with an estimated recessionary gap of $30 billion. Congress is considering the use of fiscal policy to ease the recession, but due to current political sentiments, it has determined that the maximum spending increase the government is willing to support is $6 billion. It wants to make up the remainder of the recessionary gap using tax cuts. If a spending increase of $6 billion is approved and the MPC is 0.75, by how much will taxes need to be reduced to close the remainder of the recessionary gap? Instructions: Round your answer to 2 decimal places. $____billionarrow_forwardSuppose the government implements fiscal consolidation by cutting spending while the nominal interest rate is already at zero or near zero percent. Given πeequals to π ̅ , fiscal consolidation will likely lead to: a. Increasing inflation, decreasing real interest rate and a recession b. Increasing inflation and real interest rates, and a recession c. Deflation spiral, decreasing real interest rate and a recession d. Deflation spiral, increasing real interest rate and a recession e. All of the answers here are incorrectarrow_forwardNow explain the relationship between the effectiveness of fiscal policy and the interest elasticity of investment demand. Why do the two relationships differ?arrow_forward
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