One of these answers are wrong. May somebody tell me which one and why? Thanks! 1. a. Why is the amount of transfer payments important as a percentage of total government expenditure? The size of transfer payments as a percentage of government expenditure is important because this type of expenditure is “non-productive”. The theory that fiscal policy can stimulate Aggregate Demand and that some defi cit can be good for the economy rests on how productive those funds will be when spent. Spending toward goods and services motivates growth but spending on transfer payments does not. It is easy to see why Government spending on roads and education act as investment toward growth. b. Show the eff ect of and diff erence between tax on income and tax on interest, Add a one sentence explanation to the graph to explain the eff ect and diff erence. One tax in influences the labor decision, one in influences savings and investment decisions. The tax on interest is more severe because it e ffects the growth potential in the economy. The loanable funds market has a role di fferent from the labor market and production function. A tax on labor e ffects the level that the economy is at – it lowers Real GDP. A tax on interest actually aff ects the growth potential because people are disincentivized from contributing funds that feed capital accumulation. That drives the interest rate up and businesses away from growing their business. The economy with labor tax starts at a lower level but grows with the same vigor as with no tax. The economy with the tax on interest starts at a higher level but grows more slowly. c. Explain the di fference between structural and cyclical defi cit. A structural defi cit is the result of the level of potential GDP lowering relative to its previous level but a cyclical de ficit means that potential GDP remains at the original level but Real GDP lowers away from it. These defi cits originate in automatic fiscal policy. When the economy is operating below potential GDP the amount of money the government is taking in via tax is naturally going down as a result and the amount of spending via transfer payments is going up because the economy is below full employment so more people are claiming unemployment benefi ts for one example. d. Which seems to be more severe? Due to the shift in potential GDP with structural defi cits, this type seems more severe. By contrast, the economy is expected to return to its previous level of production when a cyclical defi cit occurs as part of the business cycle but due to the permanent nature of the structural decline in GDP the economy will have to undergo a technological stimulus or capital accumulation resulting in growth to find itself back at its previous level. e. How can fiscal policy be used to stimulate the economy? Primarily when the economy is experiencing recession fiscal policy, as the theory tells us, can boost aggregate demand by either increasing expenditure (G) or cutting taxes. This impacts aggregate expenditure (Y) moving AD outward and through the multiplier eff ect, C increases moving AD further outward until long-run equilibrium is reached. f. What is the diff erence between automatic and discretionary fi scal policy? Automatic fiscal policy: with the laws currently in place directing tax rate and expenditure plans, when the economy naturally shifts as part of the business cycle the amount of revenue or receipt naturally changes. Discretionary fi scal policy: the conscientious change in spending program or tax law to stimulate production and jobs. g. What are the lags that a ffect fi scal stimulus? Are they important? The lags are recognition, law-making and impact. To demonstrate their importance, imagine that the economy is in a recession. Via unseen forces the economy starts pulling itself out of the recession (say, all people become jointly optimistic about the future which a ffects their productivity positively) but the government doesn’t recognize this so seeks to implement its own remedy. By the time they realize what should be done, pass the law and years later it takes full eff ect, the economy via the natural force has pulled itself out of recession so the law to spend more 2 or 3 years after it was originally passed now sends us into high inflation and high de ficit and debt.