1. The federal government is considering some fiscal policy alternatives. Will its choice between the following pairs of policy
changes influence the level of aggregate demand, and if so how?
a) An increase in taxes of 100 versus a reduction in transfer payments of 100.
b) An increase in highway construction of 100 versus an increase in Social Security benefits of 100.
c) A reduction in military procurement of 100 versus a reduction in scientific research of 100.
d) A reduction in mass transit programs of 100 versus a tax increase of 100.
2. Consider an economy in which the marginal propensity to consume is two-thirds, prices are constant, the multiplier is three, G is initially 1,000, taxes are autonomous (not related to income) and are initially 1,300, transfer payments are initially 300, and GDP is initially 7,000.
a) The government wishes to increase GDP to 7,300, and it is considering changing government purchases, or taxes, or transfer payments. What new levels of these fiscal policy tools would be needed? In each case, what would the new government surplus or deficit be?
b) Suppose instead that the government wished to reduce GDP to 6,400 and, again, it was considering using only one of its three available fiscal policy tools. What level of these tools would be needed? In each case, what would the government surplus or deficit be?
c) Suppose instead that the government wished to raise GDP to 7,100, but it was unwilling to run a surplus or deficit. Therefore the change in government purchases would have to be matched by an equal change in taxes. What change in government purchases and taxes would be needed?
3. The Sixteenth Amendment to the U.S. Constitution, adopted in 1913, permitted an American income tax for the first time. In view of this, explain why the multiplier was either higher or lower in the 19th century than it is today.
4. Assume that people do not change the amount of currency they wish to have in circulation. When a bank finds itself with excess reserves, it lends the excess; the borrower generally uses the funds to pay a third party, who in turn deposits the funds in a different bank. In each of the following cases, use balance sheets to trace the process of money creation (or contraction) through three banks, showing the change in the money supply at each stage.
a) Paul Prospector discovers a million dollars worth of gold, and deposits it in his bank. The required reserve ratio is 20 percent. (Hint: Use Accounting Ledger)
5. How much money in the form of bank deposits will $100 million in reserves support, if the reserve ratio is 10 percent, 20 percent, 25 percent, 33.3 percent, 50 percent, 100 percent?
