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Tax Rates, Open Market Operations and the Relationship Between Deficits and the National Debt

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Explain the pros and cons of using a change in the tax rate to achieve the desired increase in output. Be sure to thoroughly explain how the change will affect equilibrium prices, output, and unemployment.

Explain the pros and cons of using a change in open market operations to achieve the desired increase in output. Be sure to thoroughly explain how the change will affect equilibrium prices, output, and unemployment.

Describe the relationship between deficits and the national debt, and how each relates to the health of the economy.

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TAX RATE

The pros and cons of using a change in the tax rate to achieve the desired increase in output. Be sure to thoroughly explain how the change will affect equilibrium prices, output, and unemployment.

Taxation is an issue of Fiscal policy. Fiscal policy refers to nation's policy relating to the government spending, taxing, borrowing and debt management. The main objectives of the fiscal policy are:
1. Mobilization of resources
2. Acceleration of the economic growth
3. To minimize the inequalities of Income and Wealth.
There are three main constituents of the fiscal policy, these are:
1. Taxation policy
2. Public Expenditure policy
3. Public debt policy
All these constituents must work together to make the fiscal policy sound and effective

TAXATION POLICY
The main objectives of the taxation policy are:
- Mobilization of resources
- Acceleration of the economic growth
- To minimize the inequalities of Income and Wealth.
The main objectives for which taxes are levied is to raise revenue by transferring resources from the public to government and the opposite applies when the government cut the taxes so that some resources are transferred from the government to public. It will depend on the tax system that how much it has impact on the economy. The characteristics of good tax system are:
- Equity in distribution of tax burden
- It should yield a satisfactory amount for the maintenance of a government.
- It should maximize social benefit that is redistribution of wealth and reducing the inequalities of income.
It will depend on the tax system that how much it has impact on the economy.

Different strategies
If the economy is in recession then the tax credit and tax cuts will increase the disposable income and hence thus increase the overall production of the economy. It will help in recovery of the economy.

If the economy overheated then the reverse strategy can be employed.

For example, The tax cuts from the past few years have been partially successful in promoting economic growth or in preventing a deeper decline. There should be increase in the employment but in the USA this not achieved. Reduction in the taxation increases the disposable income of the society there by increasing the expenditure or consumption the economy. This in turn increases the economic growth. Many economists believe output has climbed because of higher labor productivity. So there has been no need to create new jobs. But ...

Solution Summary

This solution discusses the use of tax rates to achieve public economic policy, the use of change in open markets to achieve a desired level of market output and the relationship between deficits and national debt in approximately 1500 words.

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Multiple choice/ short answer questions : multiplier model, recession, automatic stabilizers, budget deficit, money, reserve ratio, currency to deposit ratio, Monetary policy, stimulate aggregate demand, expansionary monetary policy, AS/AD model, Countercyclical monetary policy, nominal interest rates, real interest rates, recessionary gap, autonomous expenditures, Crowding out, Automatic stabilizer, Money multiplier, Open market operations, Budget deficit, money supply, tight (restrictive) monetary policy.

1. According to the multiplier model, the best way to reduce inflation is to
a. increase aggregate demand by cutting government spending or raising taxes.
b. increase aggregate demand by raising government spending or cutting taxes.
c. decrease aggregate demand by cutting government spending or raising taxes.
d. decrease aggregate demand by raising government spending or cutting taxes.

2. If the economy goes into a recession, automatic stabilizers will do all of the following except
a. increase income tax revenues.
b. increase the budget deficit.
c. increase unemployment insurance.
d. increase welfare payments.

Refer to the following table as you answer the next question.
Year Surplus or deficit (-)
billions of dollars
1946 -15.9
1947 4.0
1948 11.8
1949 .9
1950 -3.1

3. Which statement is true?
a. The budget deficit in 1950 was $2.3 billion.
b. From 1946 to 1950, the debt was $2.3 billion.
c. From 1945 to 1950, the debt rose by $2.3 billion.
d. In 1950, the debt was $2.3 billion.

4. Money can be many things, but it is not
a. a financial liability.
b. a financial asset.
c. liquid.
d. illiquid.

5. A reserve ratio of 0.10 means that a bank loans out __________ percent of its_______
a. 10; deposit liabilities
b. 10; excess reserves
c. 90; deposit liabilities
d. 90; excess reserves

6. In the real world, the currency to deposit ratio is
a. negative.
b. zero.
c. greater than 0 but less than or equal to 1.
d. greater than 1.

7. Monetary policy affects
a. inflation only.
b. output only.
c. both inflation and output.
d. neither inflation nor output.

8. If the Bank of Canada wanted to stimulate aggregate demand, it could
a. raise the target range for the overnight financing rate, thereby reducing interest rates throughout the economy.
b. raise the target range for the overnight financing rate, thereby increasing interest rates throughout the economy.
c. lower the target range for the overnight financing rate, thereby reducing interest rates throughout the economy.
d. lower the target range for the overnight financing rate, thereby increasing interest rates throughout the economy.

9. Which of the following is an example of an expansionary monetary policy?
a. Raising the bank rate.
b. Raising the overnight financing rate.
c. Selling bonds.
d. Buying bonds.

10. Bank of Canada sales of government bonds ________ bank reserves, and _______ the money supply.
a. increase; increase
b. decrease; decrease
c. decrease; increase
d. increase; decrease

11. In the AS/AD model, an expansionary monetary policy
a. increases aggregate demand by reducing interest rates.
b. increases aggregate demand by raising interest rates.
c. reduces aggregate demand by reducing interest rates.
d. reduces aggregate demand by raising interest rates.

12. Countercyclical monetary policy in the AS/AD model involves
a. contractionary monetary policy throughout the business cycle.
b. expansionary monetary policy throughout the business cycle.
c. contractionary monetary policy during boom periods and expansionary monetary policy during recession.
d. contractionary monetary policy during recession and expansionary monetary policy during boom periods.

13. Which of the following gives the correct relationship between nominal and real interest rates?
a. real interest rate = nominal interest rate + expected inflation rate
b. nominal interest rate = real interest rate + expected inflation rate
c. expected inflation rate = nominal interest rate + real interest rate
d. nominal interest rate = real interest rate ? expected inflation rate

14. Suppose an expansionary monetary policy reduces nominal interest rates. If this is the case, it follows that the expansionary monetary policy must have
a. reduced expected inflation.
b. increased expected inflation.
c. increased expected inflation less than it reduced real interest rates.
d. reduced real interest rates less than it increased expected inflation

15. Suppose the Japanese economy faces a recessionary gap of 120. If mpc is 0.6 and the price level is constant, the government should increase autonomous expenditures
a. by 20
b. by 48
c. by 72
d. by 120

Questions 16 and 17 (Short Answer)
16. Define and briefly explain the significance of each of the following terms.
a. Crowding out
b. Automatic stabilizer
c. Money multiplier
d. Open market operations
e. Budget deficit

17. Explain how the Bank of Canada can influence interest rates and the money supply in Canada. Be specific about the tools that the Bank of Canada has available for these purposes, and describe how these tools would be used in the case of a tight (restrictive) monetary policy.

See attachment for the questions

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