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Fiscal Policy Exercise

Define: expansionary fiscal policy: Fiscal Policy that increases aggregate


demand to increase output.

Define: contractionary fiscal policy: Fiscal Policy that decreased aggregate


demand to control inflation.
Listed below are fiscal policy actions. In each case, Congress initiates the action. For each
action, indicate whether it will be expansionary or contractionary. Then, indicate whether
it would be discretionary or built-in stabilizer.
Government Action Expansionary or Discretionary or
Contractionary? Built-in
Stabilizer?
1. Recession raises the amount of Expansionary Built-in
unemployment compensation paid Stabilizer
2. Cuts personal income tax rates Expansionary Discretionary

3. Incomes rises; people pay a higher Contractionary Built-in


fraction of their incomes in taxes Stabilizer
4. As result of recession, more families Expansionary Built-in
qualify for food stamps and welfare Stabilizer
5. Eliminates the deductibility of interest Contractionary Discretionary
expense for tax purposes
6. Launches a major new space program to Expansionary Discretionary
explore Mars
7. Raises Social Security taxes paid by Contractionary Discretionary
workers
8. Corporate profits increase; government Contractionary Built-in
collects more corporate income taxes as a Stabilizer
result
9. Raises corporate income tax rates Contractionary Discretionary
10. Gives all federal employees a 5% raise Expansionary Discretionary

Testing your Understanding of Fiscal Policy

Choose either Expansionary or Contractionary fiscal policy and fill in the spaces in the
table below as follows:
Column A: AD objective I for increase in AD
D for decrease in AD
Column B: Action on taxes I for increase in taxes
D for decrease in taxes
Column C: Action of Government spending I for increase in government spending
D for decrease in government spending
Column D: Effect on Budget D for movement toward deficit
S for movement toward surplus

Col A Col B Col C Col D


AD objective Action on Action of Effect on
taxes Government Budget
spending

1. The national I D I D
unemployment rate
rises to 12%
2. Inflation is raging D I D S
and its rate is now
14% per year
3. Surveys show I D I D
consumers are losing
confidence in the
economy; retail sales
are weak, and
business Inventories
are increasing rapidly
4. Business sales and D I D S
investments are
expanding rapidly,
and economists
believe that strong
inflation lies ahead.
5. Inflation persists
while unemployment
stays high.

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