Check Yourself Solutions for Chapter 36 through Chapter 38

Chapter 36-1

  1. Individual income taxes plus Social Security and Medicare taxes represent 81% of federal revenues.

  2. A person in the fourth quintile pays an effective federal tax rate of 17.4%. On an income of $80,000, this would be $13,920 in tax. A person in the top quintile pays an effective rate of 25.5% on income of $160,000, thus a tax of $40,800. Because the person who made twice as much paid more than twice as much in tax, this gives evidence of progressivity in the tax system.

Chapter 36-2

  1. Social Security and Medicare spending currently account for just over 40% of federal spending.

  2. GDP gives us an idea of the capacity of the economy to pay debt so the debt-to-GDP ratio tells us what the debt is relative to the capacity to pay the debt.

Chapter 36-3

  1. In the next 40 years, Social Security and especially Medicare and Medicaid are likely to increase relative to GDP. This means that the level of overall government spending relative to GDP is likely to increase.

  2. If the pace of idea generation quickens, this will lead to a positive shift in the long-run aggregate supply growth curve. In other words, the economy will be able to produce more goods and services. This would lead to a decrease in the debt-to-GDP ratio (all other things equal). This would increase the government’s ability to pay for increased benefits for retirees.

B-14

Chapter 37-1

The two types of expansionary fiscal policy are the government spends more money, or the government cuts taxes and thereby gives people more money to spend.

Chapter 37-2

  1. The 2008 tax rebate was less powerful than expected because many people saved the rebate and paid down debt, rather than spending it.

  2. A permanent cut in income tax rates can generate a larger fiscal stimulus than a temporary cut because people likely will save a large portion of a temporary tax cut, to pay for future taxes. But if the tax cut is permanent, they may choose to spend more. Of course, telling people that a tax cut is permanent is quite different from getting people to believe that it is permanent!

  3. A permanent investment tax credit produces a smaller fiscal stimulus than a temporary investment tax credit because to get the temporary tax credit, firms must spend money on equipment right away but a permanent investment tax credit gives firms the option of waiting to invest.

Chapter 38-1

  1. If an inhabitant of Nebraska buys a German sports car for $30,000, this lowers the U.S. current account balance by $30,000.

  2. If a German sports car manufacturer opens a new plant in South Carolina, this investment is a capital account surplus for the United States.

  3. The current and capital accounts are two sides of the same coin. When the capital account is in surplus, the current account will tend to mirror that in deficit, and vice versa.

Chapter 38-2

  1. If the U.S. dollar is a safe haven currency, then in times of risk people will demand dollars, increasing their value.

  2. If the Fed increases the money supply, this will reduce the value of the dollar compared to the euro.

  3. If purchasing power parity holds and the nominal exchange rate is 1 pound for 2 dollars, a Big Mac should cost in London if it costs $4.00 in New York.

  4. A tariff will hinder market exchange and thus the arbitrage of differing prices. This limits purchasing power parity.

Chapter 38-3

  1. In the short run, a Fed increase in the money supply will cause a depreciation in the exchange rate, leading to an increase in U.S. exports. In the long run, the temporary boost to exports will dissipate, and the increase in the money supply will lead to inflation.

  2. In an open economy, monetary policy is more effective than fiscal policy. Expansionary monetary policy will tend to reduce interest rates, causing a currency depreciation and increased exports. In contrast, expansionary fiscal policy will tend to increase interest rates, causing an appreciation of the exchange rate and reduced exports.

Chapter 38-4

  1. A floating exchange rate describes when the value of a country’s currency is determined by the forces of supply and demand.

  2. The European Central Bank controls the monetary policy of the European Union.