Stabilizing Effect of Inherently Stable Government Spending

Automatic Stabilizers

Discretionary Fiscal Policy

Government's Role in Economic Stability

An economy experiences a sudden and significant decline in private investment, leading to a potential recession. According to the theory of economic stabilization, which statement best analyzes how the government's fiscal activities can dampen the impact of this specific shock?

A government's ability to dampen economic fluctuations stems solely from the fact that its spending on services is less volatile than private consumption and investment. The way this spending is funded through the tax system does not contribute to this stabilizing effect.

Mechanisms of Economic Stabilization

The Dual Stabilizing Forces of Government Fiscal Activity

Analyze the mechanisms of economic stabilization by matching each government fiscal component with its specific role in dampening economic fluctuations.

When an economy experiences a downturn, government tax revenues naturally decrease while spending on social support programs often increases. These fiscal changes help to soften the economic decline by supporting or increasing overall ________ ________.

An economy is initially in a stable state. A sudden, negative shock to aggregate demand occurs, such as a widespread drop in consumer confidence. Arrange the following events to demonstrate the logical sequence through which government fiscal structures can automatically dampen the resulting economic fluctuation.

Two economies, Alpha and Beta, are identical in structure, but Alpha's government spending and taxation represent 40% of its total economy, while Beta's represent only 20%. Both economies experience an identical, sudden drop in private investment. Based on the theory that government fiscal activity can dampen economic fluctuations, which statement best analyzes the most likely immediate outcome?

Critique of a Proposed Economic Stabilization Policy