Question

16. When output deviates from potential GDP, automatic stabilizers work to push the economy through the work of automatic stabilizers. Give two examples of automatic stabilizers. 17. Crowding out effect: what does it mean? 18. Distinguish between public debt and budget deficit. 19. Mention which of the two output gap occurs in the following cases: recessionary gap or inflationary gap? a. the economy is creating less output than its potential b. the economy is creating more output than its potential

Answer 1

Due to presence of HOMEWORKLIB POLICY, I am answering two questions.

16.

Ans:

Some examples of automatic stabilizers are progressive corporate and personal income taxes, and transfer systems such as unemployment insurance and welfare. Automatic stabilizers are so called because they act to stabilize economic cycles and are automatically triggered without additional government action.

They stabilize economy in following manner:

• During period of high growth, booming incomes and inflation, progressive taxes help by automatic imposition of higher tax to incomes which lie in higher brackets. This dampens demand and gives a rest to inflation.
• During periods of recession and unemployment, taxes become low as incomes fall in lower tax brackets and transfers and unemployment insurance rise which lead to relative higher spending to bring economy out of recession.

17.

Ans: A situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment or government spending is called crowding out effect.

In figure, we can see that a fiscal expansion caused IS to shift right from IS1 to IS2. In absense of money market, maximum change in income would be (Y2 - Y1). But since money market is present, fiscal expansion would cause higher money demand and higher interest rate causing fall in private investment spending. This will dampen income change by (Y3 - Y2). Due this final income change is (Y3 - Y1) only.

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