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DAY 2 PROBLEM SET Long-Run Implications of Fiscal Policy.doc

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DAY 2 PROBLEM SET Long-Run Implications of Fiscal Policy (ANSWERS).pdf

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APMac U5 L2 Video   Government deficits, the national debt and crowding out

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AP Macroeconomics: 5.4 Government Deficits and the National Debt

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How does crowding out effect the loanable funds market?

When real interest rates rise in the loanable funds market, how does that affect interest-sensitive consumption and investment?

When interest-sensitive consumption and investment decrease, how does that affect the AD curve? Price Level? Output? Unemployment?

What is the relationship between investment in capital stock and long-run economic growth?

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APMac U5 L2 Government deficits, national debt and crowding out

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Define the government budget surplus (deficit) and national debt.

Explain the issues involved with the burden of the national debt.

Define crowding out.

Explain (using graphs as appropriate) how fiscal policy may cause crowding out.

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There are long-run implications of monetary and fiscal policy.

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The government budget surplus (deficit) is the difference between tax revenues and government purchases plus transfer payments in a given year.

A government adds to the national debt when it runs a budget deficit.

A government must pay interest on its accumulated debt, thus increasing the national debt and increasingly forgoing using those funds for alternative uses. [See also crowding out.]

When a government is in budget deficit, it typically borrows to finance its spending.

A loanable funds market model can be used to show the effect of government borrowing on the equilibrium real interest rate and the resulting crowding out of private investment.

Crowding out refers to the adverse effect of increased government borrowing, which leads to decreased levels of interest-sensitive private sector spending in the short run.

A potential long-run impact of crowding out is a lower rate of physical capital accumulation and less economic growth as a result.