1.     a.     In year 1, the government operated with a:
*a deficit of $ 50  billion and a debt of $50 billion

        b.     In year 2, the government operated with a:
*a surplus of $ 50  billion and a debt of $0 (plus interest if you want to be technical)

        c.     In year 3, the government operated with a:
*a deficit of $150  billion and a debt of $150 billion

        d.     In year 4, to achieve a balanced budget the government should try to:
*increase taxes (t) by $250 billion or decrease governmental spending (G) by $250 billion

        e.     In year 5, the government operated with a:
*a deficit of $250  billion and a debt of $650 billion

        f.     How would you label the government's actions, if after year 2, the government redirected
               the budget surplus into “other” programs:
*zero debt growth or zero debt spending

        g.     How would you account for the government's budgetary performance for the five years listed
*a $650 billion debt, but with zero deficit growth between years 4 and 5

2.  a.     List and explain how the Fiscal and Monetary tools operate?
     b.     If an economy is experiencing unemployment what are the options to correct the situation.
     c.     If an economy is experiencing inflation what are the options to correct the situation.

*a.     Fiscal Tools are taxes ( t ) and governmental spending ( G )
        Monetary Tools are interest rates ( i ) and money supply ( M^S )
        both tools will manipulate the AD in order to stabilize an economy through a recession or period of inflation

*b.    In a recession the governmental goal is to increase the AD or GDP
Fiscal Tools:           decrease taxes ( t ) which increases consumption ( C ) which increases AD
                              increase governmental spending ( G ) which increases AD
Monetary Tools:     decrease interest rates ( i ) which increases investment ( I ) which increases AD
                              increase money supply ( M^S ) which increases consumption ( C ) which increases AD

*c.    In an inflation period the governmental goal is to decrease the AD or GDP
Fiscal Tools:           increase taxes ( t ) which decreases consumption ( C ) which decreases AD
                              decrease governmental spending ( G ) which decreases AD
Monetary Tools:     increase interest rates ( i ) which decreases investment ( I ) which decreases AD
                              decrease money supply ( M^S ) which decreases consumption ( C ) which decreases AD

3. Why have fiscal tools become ineffective when dealing with inflation?
*tax (t) increases and governmental spending ( G ) decreases  are politically infeasible

4. How did Stagflation cripple the economy of the 1970s
*by simultaneously increasing inflation and unemployment, it made the stabilization tools (Fiscal and Monetary Policy)
ineffective.

5. Explain how self-correcting mechanism works.  Furthermore, discuss the Keynesian critique of self correction.
*Wealth influences consumption.
Inflation:       price levels increase which decreases wealth which decreases consumption ( C ) which decreases AD
Recession:    price levels decrease which increases wealth which increases consumption ( C ) which increases AD

6. Explain the problems associated with an inflationary expectation and the “crowding out” effect.
*-- inflationary expectations: are when people expect inflation and thus they create inflation by increasing their
    current consumption ( C ).  Inflation causes a decrease in private sector investment ( I )
-- the crowding effect occurs when increases in governmental spending ( G ) cause the interest rates ( i ) to increase
    thus decrease private sector investment ( I )

7. How are Bill Clinton and George Bush similar in their economic policies?
*both promoted private sector investment ( I ) by pushing for lower interest rates ( i ) and investment tax credits
also both promoted deficit reductions and balanced budgets
8. If a recessionary gap (actual level of GDP is less than the potential) of $500 million exists and the MPS = .25, how much of correction to the AD is necessary for gap correction?

*Recessionary gap correction occurs when the AD increases. To get the exact dollar amount necessary for complete correction, first calculate the multiplier by using the formula 1/(1-MPC) or 1/MPS. If the MPS = .25, then the MPC = .75 making the multiplier 1/(1-.75) or 1/.25 = 4. To calculate the correction use the following formula (change in AD) * multipler = gap correction. (Change in AD)* 4 = $500 million. Divide both sides by the equation by the multiplier 4, that results in the change in the AD = $125 million. Since this is a recessionary gap the AD will have to increase by $125 million. This can be achieved by getting C,I,G or X to increase by $125 million or getting M to decrease $125 million. Using the Fiscal and Monetary Tools the government can either increase G by $125 Million (as stated above) or lower taxes enough to increase C by $125 million or lower interest rates to increase I by $125 million or increase the money supply enough (the government would buy bonds) to increase C by $125 million. *For an inflationary gap you would use the opposite approach