Government And Fiscal Policy Ch.12 Verified Test Bank - Macroeconomics v3.0 Complete Test Bank by LibRittenberg. DOCX document preview.
Chapter 12: Government and Fiscal Policy
Multiple Choice
1. In late 2008, the U.S. government extended unemployment insurance benefits for seven additional weeks, in recognition of the growing unemployment problem. This extension is an example of
A) automatic fiscal policy.
B) discretionary fiscal policy.
C) expansionary monetary policy.
D) supply-side fiscal policy.
Difficulty: Medium
2. All of the following are instruments of fiscal policy except
A) rebate on payroll taxes.
B) education tax credits.
C) unemployment insurance benefits.
D) an interest rate cut.
Difficulty: Easy
3. Government tax and expenditure policies that affect real GDP are called
A) automatic fiscal policy.
B) discretionary fiscal policy.
C) fiscal policy.
D) supply-side policy.
Difficulty: Easy
4. The government purchases component of aggregate demand includes
I. all purchases by government agencies of goods and services produced by firms.
II. direct production by government agencies themselves.
III. government expenditures on transfer payments.
A) I only
B) I and II only
C) I and III only
D) I, II, and III
Difficulty: Easy
5. Public investment expenditure for highways, schools, and national defense is included in which component of GDP?
A) consumption
B) gross private investment
C) government purchases
D) public investment
Difficulty: Easy
6. Payments to households that do not require anything in exchange are called
A) transfer payments.
B) government purchases.
C) consumption expenditures.
D) investment expenditures.
Difficulty: Easy
7. Which of the following statements characterizes government purchases in the United States between 2001 and 2011?
A) Government purchases as a share of GDP have declined.
B) Government purchases as a share of GDP have increased.
C) Government purchases as a share of GDP have remained constant.
D) Government purchases have fluctuated widely over this period.
Difficulty: Medium
8. Medicaid, welfare payments, and Temporary Assistance to Needy Families are classified as
A) unilateral payments.
B) transfer payments.
C) gifts.
D) income redistribution payments.
Difficulty: Medium
9. Transfer payments typically
A) rise during expansionary periods.
B) fall during recessions.
C) do not change as the economy expands and contracts during the business cycle.
D) fall during expansionary periods and rise during recessionary periods.
Difficulty: Medium
10. All of the following are examples of transfer payments except
A) welfare benefits to the poor.
B) dividend payments to the wealthy.
C) Social Security payments to the elderly.
D) unemployment compensation to the unemployed.
Difficulty: Medium
11. Which of the following statements characterizes government transfer payment spending in the United States between 1960 and 2015?
A) Transfer payment spending by the federal government and by state and local governments has decreased as a percentage of GDP.
B) Transfer payment spending by the federal government and by state and local governments has more than tripled as a percentage of GDP.
C) Transfer payment spending by the federal government and by state and local governments has remained constant as a percentage of GDP.
D) Transfer payment spending by the federal government and by state and local governments has fluctuated widely over this period.
Difficulty: Medium
12. The bulk of transfer payment spending in the United States is undertaken by
A) non-profit organizations in the private sector.
B) state governments.
C) local governments.
D) the federal government.
Difficulty: Medium
13. The three major categories of government spending are
A) government purchases, defense spending, and interest payments.
B) defense spending, Medicare and Medicaid, and net interest.
C) government purchases, transfer payments, and net interest.
D) government purchases, defense spending, and transfer payments.
Difficulty: Medium
14. The bulk of federal receipts come from
A) property taxes and personal income tax.
B) personal income tax and from payroll taxes.
C) corporate income taxes and personal income tax.
D) personal income tax and property taxes.
Difficulty: Medium
15. State and local tax receipts are dominated by
A) property taxes and state income taxes.
B) state income taxes and sales taxes.
C) property taxes and sales taxes.
D) sales taxes and business taxes.
Difficulty: Medium
16. Taxes assessed on firms and employees on wages and salaries earned are called
A) dividend taxes.
B) payroll taxes.
C) corporate profits taxes.
D) earned income taxes.
Difficulty: Easy
17. The government has a balanced budget if
A) its total revenues are equal to its total expenditures.
B) its total revenues are less than its total expenditures.
C) its total revenues are greater than its total expenditures.
D) the money supply is less than total expenditures.
Difficulty: Easy
18. The government has a budget deficit if
A) its total revenues are equal to its total expenditures.
B) its total revenues are less than its total expenditures.
C) its total revenues are greater than its total expenditures.
D) the money supply is less than total expenditures.
Difficulty: Easy
19. The government has a budget surplus if
A) its total revenues are equal to its total expenditures.
B) its total revenues are less than its total expenditures.
C) its total revenues are greater than its total expenditures.
D) the money supply is less than total expenditures.
Difficulty: Easy
20. Which of the following statements is true regarding the government budget?
A) The government’s budget has been in deficit since the 1960s.
B) The government’s budget has been in deficit since the 1960s except for a brief period since 2012.
C) The government’s budget was generally in surplus until the 1980s, then mostly in deficit since
except for a brief period between 1998 and 2001.
D) The government’s budget was generally in deficit since the 1960s,
except for a brief period between 1998 and 2001.
Difficulty: Medium
21. The sum of all past federal deficits minus any surpluses is called the
A) transfer balance.
B) national deficit.
C) national debt.
D) national budget.
Difficulty: Easy
22. The national debt
A) is the sum of all past federal deficits plus any surpluses.
B) grows when the government runs a deficit.
C) grows when government spending increases.
D) is a major problem facing the U.S. government.
Difficulty: Medium
23. The national debt
A) is the difference between total government revenues and government expenditures.
B) is the sum of all past federal deficits plus any surpluses.
C) is the sum of all past federal deficits less any surpluses.
D) grows when government spending increases.
Difficulty: Easy
24. Judged by international standards, the national debt of the United States, in terms of its national
debt as a percentage of GDP is
A) the highest among the developed nations.
B) the lowest among the developed nations.
C) above average among the developed nations.
D) below average among the developed nations.
Difficulty: Medium
25. Which of the following statements is true about the U.S. national debt?
I. Relative to the level of economic activity, the debt is well below the levels reached during
World War II.
II. The ratio of debt to GDP fell in the last years of the twentieth
century; it began rising again in 2002 and has risen substantially since the 2008 recession.
III. Judged by international standards, the U.S. national debt relative to its GDP is above average among developed nations.
A) I only
B) II only
C) III only
D) I, II, and III
Difficulty: Medium
26. If the federal budget is initially balanced and government expenditures remain constant, then an
increase in GDP will _________ tax revenues and create a budget _________.
A) increase tax revenues and create a budget surplus.
B) increase tax revenues and create a budget deficit.
C) decrease tax revenues and create a budget surplus.
D) decrease tax revenues and create a budget deficit.
Difficulty: Medium
27. If the federal budget is initially balanced and government expenditures remain constant, then a
decrease in GDP will
A) decrease tax revenues and create a budget surplus.
B) increase tax revenues and create a budget surplus.
C) decrease tax revenues and create a budget deficit.
D) increase tax revenues and create a budget deficit.
Difficulty: Medium
28. Suppose a country has a national debt of $5,000 billion, a GDP of $20,000 billion, and a
budget surplus of $130 billion. How much will its new national debt be?
A) $5,130 billion
B) $4, 870 billion
C) $15,130 billion
D) $19, 870 billion
Difficulty: Medium
29. Suppose a country has a national debt of $2,000 billion, a GDP of $28,000 billion, and a
budget deficit of $115 billion. How much will its new national debt be?
A) $2,115 billion
B) $1,885 billion
C) $28,115 billion
D) $25,885 billion
Difficulty: Medium
30. Suppose in the beginning of 2013, a country has a national debt of $5,000 billion. Its GDP in 2013 is $20,000 billion and its budget surplus of $130 billion. Compute its debt–GDP ratio at the end of the year.
A) 2.6%
B) 25.0%
C) 24.4%
D) 6.5%
Difficulty: Medium
31. Suppose in the beginning of 2013, a country has a national debt of $8,000 billion. Its GDP in
2013 is $32,000 billion and its budget deficit of $1,600 billion. Compute its debt–GDP ratio at the end of the year.
A) about 5. 0%
B) about 20,0%
C) about 25.0%
D) about 30%
Difficulty: Medium
32. Suppose a country’s debt rises by 6% and its GDP rises by 8%. What happens to the debt–GDP ratio?
A) It rises if there is a budget deficit that period.
B) It falls.
C) It rises.
D) There is insufficient information to answer the question.
Difficulty: Medium
33. Suppose a country’s debt rises by 6% and its GDP rises by 5%. What happens to the debt–GDP ratio?
A) It rises if there is a budget deficit that period.
B) It falls.
C) It rises.
D) There is insufficient information to answer the question.
Difficulty: Medium
34. One method of assessing the degree to which current fiscal policies affect future generations is through a device called
A) inter-temporal fiscal accounting.
B) generational accounting.
C) long-term debt assessment technique.
D) fiscal stabilization tool.
Difficulty: Easy
35. The use of government expenditures and taxes to influence the level of economic activity is
called
A) deficit management policy.
B) debt management policy.
C) financial policy.
D) fiscal policy.
Difficulty: Easy
36. What is an automatic stabilizer?
A) It refers to a discretionary policy that is triggered when actual output is not equal to potential output to improve the economy’s performance.
B) It refers to a stabilization program that keeps inflation in check automatically.
C) It refers to any government program that tends to reduce fluctuations in GDP automatically.
D) It refers to a government program that is automatically triggered when the economy enters a recession.
Difficulty: Easy
37. All of the following are examples of automatic stabilizers except
A) personal income taxes.
B) means-tested federal transfer payments.
C) welfare benefits.
D) government emergency spending.
Difficulty: Medium
38. An example of an automatic stabilizer is
A) personal income taxes.
B) inheritance taxes.
C) veterans’ benefits.
D) corporate dividends.
Difficulty: Medium
39. Personal income taxes and transfer payments
A) acts as automatic stabilizers.
B) magnify fluctuations in GDP.
C) are discretionary fiscal policy tools only.
D) are influenced by monetary policy.
Difficulty: Medium
40. Which of the following is an automatic stabilizer?
I. inheritance taxes
II. government payments to war veterans
III. aid to families with dependent children
IV. sales taxes
A) I, II, III, and IV
B) I, II, and III only
C) II and III only
D) III only
Difficulty: Medium
41. A transfer payment that rises automatically during a recession is
A) interest payments on the national debt.
B) unemployment compensation.
C) Social Security payments to retired persons.
D) government payments to war veterans.
Difficulty: Medium
42. Automatic stabilizers are considered
A) discretionary fiscal policies.
B) discretionary monetary policies.
C) non-discretionary fiscalpolicies.
D) non-discretionary monetarypolicies.
Difficulty: Medium
43. During a recession, rising transfer payments and falling tax collections
I. help cushion households from the impact of the recession.
II. buffers the fall in real GDP (relative to a situation where transfer payments do not rise and
tax revenues do not fall).
III. tend to increase a budget deficit or reduce a budget surplus.
A) I only
B) I and II only
C) II and III only
D) I, II, and III
Difficulty: Medium
44. During an expansion, which of the following occur because of automatic stabilizers?
I. Income tax revenues tend to rise.
II. Government transfer payments tend to rise.
III. The government’s budget deficit tends to fall or its budget surplus tends to rise.
IV. They tend to amplify the rise in real GDP.
A) I and III only
B) I, II, and III only
C) I, III, and IV only
D) I, II, III, and IV
Difficulty: Medium
45. During a contraction,
A) higher income tax revenues tend to automatically increase a budget deficit or reduce a budget surplus.
B) higher income tax revenues tend to automatically increase a budget surplus or reduce a budget deficit.
C) lower income tax revenues tend to automatically increase a budget deficit or reduce a budget surplus.
D) lower income tax revenues tend to automatically increase a budget surplus or reduce a budget deficit.
Difficulty: Medium
46. During an economic expansion,
A) higher income tax revenues tend to automatically increase a budget deficit or reduce a budget surplus.
B) higher income tax revenues tend to automatically increase a budget surplus or reduce a budget deficit.
C) lower income tax revenues tend to automatically increase a budget deficit or reduce a budget surplus.
D) lower income tax revenues tend to automatically increase a budget surplus or reduce a budget deficit.
Difficulty: Medium
47. In general, personal income taxes
A) rise automatically during a recession.
B) rise automatically during an expansion.
C) rise automatically during a contraction.
D) are decreased during a recession through legislative actions of Congress.
Difficulty: Medium
48. During a recession, unemployment insurance ensures that
A) firms layoff fewer of its employees than it would if there is no unemployment insurance.
B) disposable income increases as GDP falls.
C) disposable income does not fall by as much as GDP decreases.
D) the marginal propensity to consume increases.
Difficulty: Medium
49. Changes in expenditures and taxes that occur through automatic stabilizers
A) shift the aggregate demand curve to the right in the event of an economic expansion.
B) shift the aggregate demand curve to the left in the event of an economic contraction.
C) do not shift the aggregate demand curve.
D) cause a movement up along the aggregate demand curve the event of an economic expansion
and a movement down along the aggregate demand curve the event of an economic contraction.
Difficulty: Medium
50. Which of the following is an advantage of automatic stabilizers?
A) The lag for automatic stabilizers is relatively long.
B) It is much easier to measure the impact of automatic stabilizers compared to the impact of discretionary fiscal policy.
C) There is no administrative cost to implementing automatic stabilizers.
D) Because they affect disposable personal income directly, automatic stabilizers act swiftly to reduce the degree of changes in real GDP.
Difficulty: Medium
51. Automatic stabilizers
A) increase the problems that lags cause in using fiscal policy as a stabilization tool.
B) are changes in taxes or government spending that increase aggregate demand without requiring policymakers to act when the economy goes into recession.
C) are changes in taxes or government spending that policymakers agree to when the economy goes into recession.
D) are part of discretionary fiscal policy.
Difficulty: Medium
52. Discretionary fiscal policy refers to
A) deliberate government efforts to stabilize the economy through government spending and taxes.
B) the use of automatic stabilizers and intervention policies to stabilize the economy.
C) any government policy that requires a lag period of at least three months.
D) the deliberate use of government spending and taxes to complement the effects of monetary
policy in an effort to stabilize the economy.
Difficulty: Easy
53. Which of the following describes a discretionary fiscal policy action/program?
A) the progressive income tax system
B) The government increases funding for the Dislocated Worker Program, a federal initiative that provides retraining and career counseling.
C) the unemployment compensation program
D) the system of welfare programs
Difficulty: Medium
54. Which of the following describes a discretionary fiscal policy action/program?
A) the progressive income tax system
B) the unemployment compensation program
C) Congress authorizes a temporary increase in unemployment insurance benefits for an additional seven weeks.
D) the system of welfare programs
Difficulty: Medium
55. Suppose Congress increases the corporate profit tax rates. This is an example of
A) discretionary fiscal policy of the expansionary variety.
B) automatic fiscal policy of the expansionary variety.
C) discretionary fiscal policy of the contractionary variety.
D) automatic fiscal policy of the contractionary variety.
Difficulty: Medium
56. In 2003, Congress passed a substantial cut in income taxes. The Federal Reserve also lowered interest rates. How can these two actions be categorized?
A) Both actions can be categorized as fiscal policy.
B) Both actions can be categorized as monetary policy.
C) The tax cut can be categorized as monetary policy and the lowering of interest rates can be categorized as fiscal policy.
D) The tax cut can be categorized as fiscal policy and the lowering of interest rates can be categorized as monetary policy.
Difficulty: Medium
57. Expansionary fiscal policy includes
A) increasing taxes and increasing government purchases.
B) lowering interest rates, decreasing taxes and increasing transfer payments.
C) decreasing taxes and increasing government expenditures.
D) lowering the interest rates, decreasing taxes and decreasing government spending.
Difficulty: Medium
58. An expansionary fiscal policy
I. includes an increase in government spending.
II. includes tax cuts.
III. increases a government budget deficit or reduces a government budget surplus.
A) I, II, and III
B) I and II only
C) I and III only
D) II and III only
Difficulty: Medium
59. Contractionary fiscal policy includes
A) increasing taxes and increasing government purchases.
B) raising interest rates, increasing taxes, and decreasing transfer payments.
C) increasing taxes and decreasing government expenditures.
D) raising interest rates, decreasing taxes, and decreasing government spending.
Difficulty: Medium
60. A contractionary fiscal policy
I. decreases a government budget deficit or increases a government budget surplus.
II. includes tax cuts.
III. may include discretionary cuts in transfer payments.
A) I, II, and III
B) I and II only
C) I and III only
D) II and III only
Difficulty: Medium
61. An expansionary fiscal policy shifts the aggregate demand curve
A) to the right and is used to close an inflationary gap.
B) to the right and is used to close a recessionary gap.
C) to the left and is used to close an inflationary gap.
D) to the left and is used to close a recessionary gap.
Difficulty: Medium
62. A contractionary fiscal policy shifts the aggregate demand curve
A) to the right and is used to close an inflationary gap.
B) to the right and is used to close a recessionary gap.
C) to the left and is used to close an inflationary gap.
D) to the left and is used to close a recessionary gap.
Difficulty: Medium
63. In the United States, most of the government’s taxing and spending is
A) to stabilize the economy and move it to its potential output.
B) to bring about greater income equality.
C) to keep inflation at a moderate level.
D) for purposes other than economic stabilization.
Difficulty: Medium
64. A recessionary gap can be closed with
A) using a contractionary monetary policy.
B) an increase in taxes.
C) a decrease in government purchases.
D) using an expansionary fiscal policy.
Difficulty: Medium
65. An inflationary gap can be closed with
A) using an expansionary monetary policy.
B) using a policy action such as a reduction in taxes.
C) using a policy action such as a reduction in government purchases.
D) imposing price controls to prevent prices from rising.
Difficulty: Medium
66. If there is an inflationary gap in the economy, discretionary fiscal policy would likely involve
an action to
A) shift the aggregate demand curve to the right.
B) shift the aggregate demand curve to the left.
C) shift both the aggregate demand curve and aggregate supply curve to the right.
D) shift both the aggregate demand curve and aggregate supply curve to the left.
Difficulty: Medium
67. If there is a recessionary gap in the economy, discretionary fiscal policy would likely involve
an action to
A) shift the aggregate demand curve to the right.
B) shift the aggregate demand curve to the left.
C) shift both the aggregate demand curve and aggregate supply curve to the right.
D) shift both the aggregate demand curve and aggregate supply curve to the left.
Difficulty: Medium
68. Suppose fiscal authorities raise state income tax rates. As a result, disposable income falls, thereby
A) decreasing consumption spending, and causing the aggregate demand curve to shift to the left.
B) decreasing consumption spending, and causing a movement along a given aggregate demand curve.
C) increasing saving, and causing the aggregate demand curve to shift to the left.
D) increasing saving, and causing a movement along a given aggregate demand curve.
Difficulty: Medium
Use the following to answer questions 69-73.
Exhibit: Fiscal Policy 1
69. (Exhibit: Fiscal Policy 1) The economy is initially at output level Y1 and there is
A) an inflationary gap.
B) a recessionary gap.
C) equilibrium at full employment.
D) a short-run and a long-run equilibrium.
Difficulty: Medium
70. (Exhibit: Fiscal Policy 1) At output level Y1,
A) potential output is greater than actual output.
B) the economy is operating at a point outside its production possibilities curve.
C) the actual unemployment rate is less than the natural rate of unemployment.
D) aggregate demand will fall to restore equilibrium.
Difficulty: Medium
71. (Exhibit: Fiscal Policy 1) In this situation, if policymakers want to close the output gap with fiscal policies that will stimulate aggregate demand, what should they do?
A) establish a consumption tax to encourage savings
B) increase government spending
C) loosen environmental regulations to lower businesses cost of production
D) raise interest rates
Difficulty: Medium
72. (Exhibit: Fiscal Policy 1) If discretionary fiscal policy is used to eliminate the gap, policy actions will
A) shift the aggregate demand curve to the right until long-run equilibrium is restored at a price
level, P1 and output level, Yp.
B) shift the short-run aggregate supply curve to the right until long-run equilibrium is restored at a
price level, P1 and output level, Yp.
C) shift the aggregate demand curve to the right until long-run equilibrium is restored at a price
level, P2 and output level, Yp.
D) shift the aggregate demand curve and the short-run aggregate supply curve to the right until
long-run equilibrium is restored at a price level corresponding to point d and output level, Yp.
Difficulty: Medium
73. (Exhibit: Fiscal Policy 1) . Assume that the economy is initially at Y1. A nonintervention policy would result in the restoration of potential output by allowing the
A) the aggregate demand curve to shift to the right.
B) the short-run aggregate supply curve to shift to the right.
C) the aggregate demand curve to shift to the left.
D) the short-run aggregate supply curve to shift to the left.
Difficulty: Medium
Use the following to answer questions 74-78.
Exhibit: Fiscal Policy 2
74. (Exhibit: Fiscal Policy 2) If real GDP is equal to Yr, there is
A) an inflationary gap.
B) a recessionary gap.
C) equilibrium at full employment.
D) a short-run and a long-run equilibrium.
Difficulty: Medium
75. (Exhibit: Fiscal Policy 2) At output level Yr,
A) potential output is greater than actual output.
B) the expected price level equals actual price level.
C) the actual unemployment rate is less than the natural rate of unemployment.
D) aggregate demand will fall over time to restore equilibrium.
Difficulty: Medium
76. (Exhibit: Fiscal Policy 2) Suppose real GDP is equal to Yr. If policymakers want to close the output gap with demand management policies, what should they do?
A) lower corporate profit tax rates to encourage investments
B) increase investment tax credits to businesses
C) decrease government spending on transfer payments and on final goods and services
D) lower interest rates
Difficulty: Medium
77. (Exhibit: Fiscal Policy 2) If discretionary fiscal policy is used to eliminate the gap, policy actions will
A) shift the aggregate demand curve to the left until long-run equilibrium is restored at a price
level, Pj and output level, Yp.
B) shift the aggregate demand curve and the short-run aggregate supply curve to the left until
long-run equilibrium is restored at a price level Pk and output level, Yp.
C) shift the aggregate demand curve to the left until long-run equilibrium is restored at a price
level, Pr and output level, Yp.
D) shift the short-run aggregate supply curve to the left until long-run equilibrium is restored at a
price level, Pr and output level, Yp.
Difficulty: Medium
78. (Exhibit: Fiscal Policy 2) Assume that the economy is initially at Yr. A nonintervention policy
would return the economy to its potential output by
A) allowing the short-run aggregate supply to shift to the right.
B) allowing the short-run aggregate supply to shift to the left.
C) allowing the aggregate demand to shift to the left.
D) allowing the aggregate demand to shift to the right.
Difficulty: Medium
79. A change in government purchases shifts the aggregate demand curve by an amount equal to the A) change in consumption marginal propensity to consume.
B) change in government purchases money multiplier.
C) change in government purchases spending multiplier.
D) change in the spending multiplier change in government purchases.
Difficulty: Medium
80. Suppose the economy is in long-run equilibrium. If the federal government cuts government
spending, which of the following is likely to result?
A) an increase in real GDP and an increase in the price level
B) an increase in unemployment and an increase in the price level
C) a decrease in unemployment and a decrease in the price level
D) a decrease in the price level and an increase in unemployment
Difficulty: Medium
81. Suppose a country decreases government purchases by $400 billion. Suppose the government spending multiplier is 1.5 and the economy’s real GDP is $8,000 billion. This contractionary policy action shifts the aggregate demand curve to the left by
A) $12,000 billion.
B) $600 billion.
C) $533.3 billion.
D) $266.6 billion.
Difficulty: Medium
82. Suppose a country increases government purchases by $700 billion. Suppose the government spending multiplier is 2 and the economy’s real GDP is $6,000 billion. This policy action shifts the aggregate demand curve to the right by
A) $12,000 billion.
B) $3,000 billion.
C) $1,400 billion.
D) $350 billion.
Difficulty: Medium
83. The impact of instituting investment tax credits is
A) to stimulate private sector investments and increase aggregate demand.
B) to stimulate private production and increase aggregate supply.
C) to encourage individuals to save in an effort to increase funds available for investment.
D) to curtail in excessive lending by financial institutions.
Difficulty: Medium
84. Suppose the government increases the corporate income tax rate. This is
A) an expansionary fiscal policy that will shift the aggregate demand curve to the right by an
amount equal to the initial change in corporate income tax revenue times the spending multiplier.
B) a contractionary fiscal policy that will shift the aggregate demand curve to the left by an
amount equal to the initial change in investment times the spending multiplier.
C) a contractionary fiscal policy that will shift the aggregate demand curve to the left by an
amount equal to the initial change in the corporate income tax rate times the spending multiplier.
D) an automatic fiscal policy that will shift the aggregate demand curve to the left by an
amount equal to the initial change in investment times the spending multiplier.
Difficulty: Medium
85. Suppose the government institutes a new investment tax credit. This is likely to
A) shift the short-run aggregate supply curve to the right by an amount equal to the amount of tax credit times the spending multiplier.
B) shift the aggregate demand curve to the right by an amount equal to the amount of tax credit times the spending multiplier.
C) shift the short-run aggregate supply curve to the right by an amount equal to the initial change in investment times the spending multiplier.
D) shift the aggregate demand curve to the right by an amount equal to the initial change in investment times the spending multiplier.
Difficulty: Medium
86. Suppose a country institutes an investment tax credit and that leads to an initial increase in investment spending of $100 billion. Suppose the multiplier is 1.5 and the economy’s real GDP is $5,000 billion. This action is
A) expansionary and will shift the aggregate demand curve to the right by $750 billion.
B) expansionary and will shift the aggregate demand curve to the right by $150 billion.
C) expansionary and will shift the aggregate demand curve to the left by $7500 billion.
D) expansionary and will shift the aggregate demand curve to the left by $150 billion.
Difficulty: Medium
87. Suppose a country repeals an investment tax credit and that leads to a decrease in investment spending of $100 billion. Suppose the multiplier is 1.2 and the economy’s real GDP is $5,000 billion. This contractionary action
A) will shift the aggregate demand curve to the left by $120 billion.
B) will shift the aggregate demand curve to the left by $6,000 billion.
C) will shift the aggregate supply curve to the left by $120 billion.
D) will shift the aggregate supply curve to the left by $6,000 billion.
Difficulty: Medium
88. Suppose that income taxes are reduced by $400 billion and households increase consumption by
80% of the resulting change in disposable income. Suppose also that the multiplier is 2.
What is the marginal propensity to consume?
A) 0.2
B) 0.4
C) 0.8
D) 1.6
Difficulty: Medium
89. Suppose that when income taxes are reduced by $400 billion, households increase consumption
by 80% of the resulting change in disposable income. Suppose also that the multiplier is 2. At a given price level, the aggregate demand curve shifts to the right by
A) $320 billion.
B) $400 billion.
C) $640 billion.
D) $800 billion.
Difficulty: Difficult
90. Suppose that income taxes are increased by $600 billion. If the marginal propensity to consume is 0.75 and the spending multiplier is 4, by how much will the aggregate demand curve shift at a given price level?
A) $2,400 billion
B) $1,800 billion
C) $600 billion
D) $450 billion
Difficulty: Difficult
91. An increase in government transfer payments will shift the aggregate demand curve to the right
A) by the initial change in consumption arising from the change in transfer payment × the spending multiplier.
B) by the initial change in income arising from the change in transfer payment × the spending
multiplier.
C) by the change in transfer payments × times the spending multiplier.
D) by the change in transfer payments × times the marginal propensity to consume.
Difficulty: Medium
92. Consider two fiscal policy actions.
I. a $400 billion reduction in income taxes
II. a $400 billion increase in government purchases
Which policy will have a bigger impact on aggregate demand?
A) Both policies will have the exact same impact.
B) Policy II because it affects aggregate demand directly.
C) Policy I because it affects disposable income directly.
D) Policy I because it works through consumption which is the largest component of aggregate
demand.
Difficulty: Medium
93. Which of the following best explains why a $10 billion increase in transfer payments has a smaller impact on aggregate demand than a $10 billion increase in government purchases?
A) An increase in government purchases can be paid for with a bond issue while transfer payments
must be funded by taxes.
B) An increase in transfer payments can be paid for by borrowing, but an increase in government purchases must ultimately be funded by tax increases.
C) Households save part of an increase in income while the entire increase in government purchases represents additional spending.
D) An increase in transfer payments does not create a multiplier effect, but an increase in government purchases does.
Difficulty: Medium
Use the following to answer questions 94-98.
Exhibit: Fiscal Policy Options
94. (Exhibit: Fiscal Policy Options) If the aggregate demand curve is AD0, which of the following is the most appropriate discretionary fiscal policy to pursue?
A) increase government spending, increase individual income tax rates, and increase corporate
income tax rates
B) increase government spending, increase individual income tax rates, and decrease corporate
income tax rates
C) increase government spending, decrease individual income tax rates, and decrease corporate
income tax rates
D) maintain existing government spending, individual income tax rates, and corporate income tax
rates
Difficulty: Medium
95. (Exhibit: Fiscal Policy Options) If the aggregate demand curve is AD1, which of the following is the most appropriate discretionary fiscal policy to pursue?
A) a contractionary fiscal policy involving reductions in government spending and increases in
income tax rates
B) a contractionary fiscal policy involving reductions in government spending and decreases in
income tax rates
C) an expansionary fiscal policy involving increases in government spending and increases in
investment tax credits
D) an expansionary fiscal policy involving increases in government spending and decreases in
investment tax credits
Difficulty: Medium
96. (Exhibit: Fiscal Policy Options) Suppose the aggregate demand curve is AD1. All of the following events would more likely bring the economy back to the natural rate of unemployment except
A) The government orders a one-time surcharge of 10% to be added to individual income tax
liabilities.
B) Businesses increase investment in response to tax breaks for businesses.
C) The Federal Reserve buys bonds on the open market.
D) The government orders a cut in withholding rates designed to increase disposable income and boost consumption.
Difficulty: Medium
97. (Exhibit: Fiscal Policy Options) If the aggregate demand curve is AD2, which of the following is the most appropriate discretionary fiscal policy to pursue?
A) a contractionary fiscal policy involving reductions in government spending and decreases in
income tax rates
B) a contractionary fiscal policy involving reductions in government spending and increases in
income tax rates
C) an expansionary fiscal policy involving increases in government spending and increases in
income tax rates
D) an expansionary fiscal policy involving increases in government spending and decreases in
income tax rates
Difficulty: Medium
98. (Exhibit: Fiscal Policy Options) Suppose the aggregate demand curve is AD2. All of the following events would more likely bring the economy back to the natural rate of unemployment except
A) the government orders a one-time surcharge of 10% to be added to individual income tax
liabilities.
B) the government raises business taxes.
C) the Federal Reserve sells bonds on the open market.
D) the government orders a cut in withholding rates designed to increase disposable income and boost consumption.
Difficulty: Medium
99. As discussed in the Case in Point on the size of the fiscal multiplier, a study conducted by Jonathan Parker on the effect of fiscal policy during recessions suggests that
A) the multiplier effect of fiscal policy is much less than that for monetary policy.
B) temporary fiscal policy financed through government borrowing implies a multiplier value between 0.8 and 1.5.
C) fiscal policy has little effect on the economy and that the multiplier value is effectively zero.
D) statistical models are inadequate to determine the multiplier and the multiplier value likely varies based on the state of the economy.
Difficulty: Medium
100. As discussed in the Case in Point on the size of the fiscal multiplier, a study conducted by John Taylor on the effect of fiscal policy since the year 2000 suggests that
A) the multiplier effect of fiscal policy is much less than that for monetary policy.
B) temporary fiscal policy financed through government borrowing implies a multiplier value between 0.8 and 1.5.
C) fiscal policy has little effect on the economy and that the multiplier value is effectively zero.
D) statistical models are inadequate to determine the multiplier and the multiplier value likely varies based on the state of the economy.
Difficulty: Medium
101. The various studies of the size of the fiscal multiplier by different economists suggest
A) general agreement that the fiscal multiplier value is relatively high.
B) general agreement that the fiscal multiplier value has a range between 0.8 and 1.2.
C) general agreement that the fiscal multiplier value is zero.
D) there is a wide range of opinion on the size of the fiscal multiplier.
Difficulty: Medium
102. Which of the following statements is true?
A) Unlike monetary policy, fiscal policy is not subject to lags.
B) Like monetary policy, fiscal policy is also subject to the same types of lags.
C) In general, fiscal policy lags are much shorter than monetary policy lags.
D) Although both monetary and fiscal policies are subject to lags, fiscal policy lags are easier to
eliminate.
Difficulty: Medium
103. Recognition lags in fiscal policy stem largely from
A) the fact that it takes time before a fiscal policy, such as a change in government purchases or a
change in taxes, is agreed to and put into effect.
B) the fact that it takes time for a policy action to have its full effect on aggregate demand.
C) the difficulty of collecting economic data in a timely and accurate fashion.
D) households and businesses may not respond to fiscal policy to the extent that policy makers had
hoped, for example, they may not be as responsive to a tax cut .
Difficulty: Medium
104. Some economists argue that
A) discretionary monetary policy is ineffective because of its long identification lag.
B) discretionary fiscal policy is ineffective because of its long recognition lag.
C) discretionary monetary policy is ineffective because of its long implementation lag.
D) discretionary fiscal policy is ineffective because of its long implementation lag.
Difficulty: Medium
105. Which of the following contributes to implementation lag for discretionary fiscal policy?
A) the time it takes to secure legislative approval for policy actions
B) the time it takes for economic agents to respond to policy actions
C) the difficulty of collecting economic data in a timely manner
D) the time it takes to borrow funds to finance the fiscal policy
Difficulty: Medium
106. Which of the following statements is true about fiscal policy lags?
A) Automatic stabilizers have a much shorter impact lag than discretionary fiscal policy.
B) Although the recognition lag is equally long for discretionary fiscal policy and for automatic stabilizers, the latter avoid implementation lag because automatic stabilizers are triggered automatically.
C) Unlike discretionary fiscal policy, automatic stabilizers respond automatically to changes in the economy, thus avoiding the recognition and implementation lags.
D) Although automatic stabilizers have a much shorter lag, discretionary fiscal policy instruments have a more potent impact on the economy because they are more precise.
Difficulty: Medium
107. An expansionary fiscal policy is likely to result in the Treasury
A) selling more bonds, the prices of bonds falling, and interest rates falling.
B) buying more bonds, the prices of bonds rising, and interest rates falling.
C) selling more bonds, the prices of bonds rising, and interest rates rising.
D) selling more bonds, the prices of bonds falling, and interest rates rising.
Difficulty: Medium
108. An expansionary fiscal policy is likely to
A) increase borrowing by the Treasury through the sale of bonds.
B) decrease borrowing by the Treasury through the purchase of bonds.
C) increase borrowing by the Treasury through the purchase of bonds.
D) decrease borrowing by the Treasury through the sale of bonds.
Difficulty: Medium
109. An expansionary fiscal policy is likely to
A) decrease a government budget surplus (or increase a budget deficit) and increase borrowing by the Treasury which will sell more bonds.
B) increase a government budget surplus (or increase a budget deficit) and decrease borrowing by the Treasury which will buy more bonds.
C) increase a government budget surplus (or increase a budget deficit) and increase borrowing by the Treasury which will sell more bonds.
D) decrease a government budget surplus (or increase a budget deficit) and decrease borrowing by the Treasury which will buy more bonds.
Difficulty: Medium
110. Which of the following statements is true regarding expansionary fiscal policy?
A) It leads to an increase in the supply of bonds by the Treasury.
B) It leads to a fall in interest rates.
C) It leads to an increase in net exports.
D) It tends to reduce to size of government.
Difficulty: Medium
111. Expansionary fiscal policy leads to
A) lower exchange rates, increased exports, and increased imports.
B) higher exchange rates, decreased exports, and decreased imports.
C) lower exchange rates, decreased exports, and decreased imports.
D) higher exchange rates, decreased exports, and increased imports.
Difficulty: Medium
112. Expansionary fiscal policy leads to
A) lower interest rates which reduce the demand for a nation’s currency, and causes its exchange
rate to fall.
B) higher interest rates which increase the demand for a nation’s currency, and causes its
exchange rate to rise.
C) higher interest rates which reduce the demand for a nation’s currency, and causes its exchange
rate to rise.
D) lower interest rates which increase the demand for a nation’s currency, and causes its
exchange rate to rise.
Difficulty: Medium
113. An expansionary fiscal policy is likely to result in
A) higher interest rates and lower private investment.
B) lower interest rates and higher private investment.
C) higher interest rates and higher private investment.
D) lower interest rates and lower private investment.
Difficulty: Medium
114. The term “crowding out” refers to the phenomenon that occurs when increased government
spending
A) raises the price level and reduces consumption.
B) leads to higher interest rates which reduces private investments.
C) leads to higher bond prices which decreases the demand for Treasury bonds.
D) leads to increased budget deficits that ultimately warrant increases in income taxes.
Difficulty: Medium
115. Which of the following is an example of crowding out?
A) A decrease in the rate of growth of the stock of money decreases GDP.
B) A deficit causes an increase in interest rates, which causes a decrease in investment spending.
C) An increase in tariffs causes a decrease in imports.
D) A decrease in government housing subsidies causes an increase in private spending on housing.
Difficulty: Medium
116. Crowding out occurs when expansionary fiscal policy leads to
A) a higher money supply and a reduction in net exports.
B) a higher money supply and a reduction in the interest rate.
C) a higher interest rate and a reduction in private investment.
D) a higher price level and a reduction in the money supply.
Difficulty: Medium
117. The crowding-out effect refers to which of the following?
A) reductions in aggregate demand that occur as the government enacts a fiscal policy that is intended to eliminate an inflationary gap
B) price increases that result in less purchasing power for consumers
C) increases in consumption spending that leave fewer resources available for the economy to use to create capital
D) reductions in private investment spending that offset increases in other spending
Difficulty: Medium
118. If private sector investment does not respond much to interest rate changes, then
A) there will be more crowding out when expansionary policies are undertaken.
B) there will be less crowding out when expansionary policies are undertaken.
C) fiscal policy will be less effective than monetary policy.
D) monetary policy will be more effective than fiscal policy.
Difficulty: Medium
119. Suppose the government increases government purchases and there is some crowding out.
As a result
A) the rightward shift of the aggregate demand curve due to increased government purchases is
reinforced by the crowding out effect.
B) the rightward shift of the aggregate demand curve due to increased government purchases is
offset to some degree by the crowding out effect.
C) the rightward shift of the aggregate demand curve due to increased government purchases is
completely offset by the crowding out effect.
D) the aggregate demand curve shifts right due to increased government purchases and the short-
run aggregate supply curve shifts left due to the crowding out effect.
Difficulty: Medium
120. When contractionary fiscal policy leads to
A) less private investment because of higher interest rates, the change in investment is called crowding in by economists.
B) more private investment because of lower interest rates, the change in investment is called crowding in by economists.
C) less private investment because of lower interest rates, the change in investment is called crowding in by economists.
D) less private investment because of higher interest rates, the change in investment is called crowding out by economists.
Difficulty: Hard
121. Which of the following are possible consequences when the government reduces government
purchases to address an inflationary gap?
I. increase in the price of bonds
II. increase in net exports
III. decrease in the federal budget deficit (or increase the surplus)
IV. decrease in the exchange rate
A) I, II, III, and IV
B) I and III only
C) I, III, and IV only
D) II, III, and IV only
Difficulty: Hard
122. A contractionary fiscal policy is likely to
A) increase government borrowing, thereby shifting the supply curve for bonds to the right.
B) reduce government borrowing, thereby shifting the supply curve for bonds to the left.
C) increase government borrowing, thereby shifting the demand curve for bonds to the right.
D) reduce government borrowing, thereby shifting the demand curve for bonds to the left.
Difficulty: Medium
123. A contractionary fiscal policy negates some of the leftward shift of the aggregate demand curve because the resulting fall in interest rates
A) increases the quantity of investment, raises the exchange rate and boosts net exports.
B) discourages savings, decreases the quantity of investment, raises the exchange rate, and reduces net exports.
C) increases the quantity of investment, lowers the exchange rate, and boosts net exports.
D) discourages savings, increases consumption, and reduces the quantity of investment and imports.
Difficulty: Hard
124. A contractionary fiscal policy is likely to
A) reduce a government budget deficit and reduce borrowing by the Treasury.
B) increase a government budget deficit and increase borrowing by the Treasury.
C) reduce a government budget deficit and increase borrowing by the Treasury.
D) increase a government budget deficit and reduce borrowing by the Treasury.
Difficulty: Medium
125. Contractionary fiscal policy will lead to a(n)
A) decrease in the supply of dollars in the foreign exchange market.
B) fall in interest rates.
C) increase in the demand for dollars in the foreign exchange market.
D) reduction in exports.
Difficulty: Medium
126. The impact of fiscal policy is
A) magnified because of crowding out and weakened because of crowding in.
B) magnified because of crowding in and weakened because of crowding out.
C) magnified because of crowding out and crowding in.
D) weakened because of crowding out and crowding in.
Difficulty: Medium
127. Suppose the economy experiences an inflationary gap. Policymakers who believe that
government is too big would favor which of the following policies to close the gap?
A) reduction in government spending
B) increases in income tax rates
C) increases in corporate tax rates
D) increases in interest rates
Difficulty: Medium
128. Suppose the economy experiences a recessionary gap. Policymakers who believe that
government is too big would favor which of the following policies to close the gap?
A) decreases in transfer payment
B) decreases in income tax rates
C) increases in government purchases
D) increases in interest rates
Difficulty: Medium
129. Suppose the economy experiences a recessionary gap. Policymakers who believe that the
private sector has failed to provide adequately, a host of services that would benefit society would favor which of the following policies to close the gap?
A) subsidies to private firms to spur production
B) decreases in income tax rates
C) increases in government purchases
D) decreases in interest rates
Difficulty: Medium
130. Supply-side economics is the school of thought that advocates the use of
A) monetary policy to stimulate long-run aggregate supply.
B) fiscal policy to stimulate long-run aggregate demand.
C) monetary policy to stimulate short-run aggregate demand.
D) fiscal policy to stimulate long-run aggregate supply.
Difficulty: Medium
131. Which of the following would supply-side economists advocate?
I. reducing tax rates in order to encourage people to work more
II. providing investment tax credits to stimulate capital formation spending
III. increasing government spending
IV. increasing transfer payments to those who want to be retrained for employment
A) I, II, III, and IV
B) I, II, and III only
C) I, II, and IV only
D) I and II only
Difficulty: Medium
Use the following to answer questions 132-136.
Exhibit: Supply-Side Economics
132. (Exhibit: Supply-Side Economics) At income level Y1, there is a(n)
A) inflationary gap, and expansionary policies may be initiated.
B) recessionary gap, and contractionary policies may be initiated.
C) recessionary gap.
D) recessionary gap, and the Fed is likely to decrease the money supply.
Difficulty: Medium
133. (Exhibit: Supply-Side Economics) If the economy’s long-run aggregate supply curve is LRAS1, then at
price level P1 and real GDP level YP1, there is
A) an inflationary gap.
B) an opportunity to use discretionary fiscal or monetary policy to improve the economy.
C) no gap, but the economy is not at its natural level of employment.
D) no gap, and the economy is at its natural level of employment.
Difficulty: Medium
134. (Exhibit: Supply-Side Economics) Assume that the economy is initially at Y1. If economists advocate
policies to promote economic growth, such as those which encourage investment and work effort, which of the following would occur?
A) a shift to the left in the long-run aggregate supply (LRAS) and the short-run aggregate supply
(SRAS) curves
B) a decrease in aggregate demand
C) a shift to the right in both SRAS and LRAS
D) a shift to the right of SRAS and to the left of LRAS
Difficulty: Medium
135. (Exhibit: Supply-Side Economics) If the economy’s long-run aggregate supply curve is LRAS1, and if the economy is in equilibrium at Y1, supply-side economists would advocate
A) tax increases to stimulate investment and work effort.
B) tax cuts to stimulate LRAS and SRAS and move them to LRAS2 and SRAS2.
C) tax cuts to shift aggregate demand from AD2 to AD1.
D) tax increases to reduce inflationary pressure in the economy.
Difficulty: Medium
136. (Exhibit: Supply-Side Economics) If the economy is initially at Y1, supply-side economists would
advocate
A) lower taxes to encourage people to work more.
B) reductions in investment tax credits to stimulate capital formation.
C) tax increases to encourage more people to work.
D) increased transfer payments to help the unemployed.
Difficulty: Medium
137. Suppose the economy has a recessionary gap. If supply-side effects are very strong in relation to the demand-side effects,
A) the impact of tax cuts will be strengthened because the increase in disposable income induces consumption, which in turn encourages firms to expand production, thereby shifting the short-run aggregate supply curve to the right.
B) the impact of tax cuts will be strengthened because in addition increasing aggregate demand, long-run and short-run aggregate supply will also increase.
C) the impact of increased transfer payments to help re-tool the unemployed with new skills will be strengthened, thereby shifting the aggregate demand curve further to the right.
D) the impact of increased transfer payments to help re-tool the unemployed with new skills will be strengthened, thereby shifting the short-run aggregate supply curve to the right.
Difficulty: Medium
138. As discussed in the Case in Point on the degree of crowding out of Canadian private investment as a result of government expenditures from 1961–2000, Professor Baotai Wang concluded that
A) all types of government spending—spending on health and education, on infrastructure and
capital, on defense, on debt services, and on government and social services—lead to crowding out.
B) government expenditures that increased human capital, such as spending on health and
education, are more likely to lead to crowding out than other types of government expenditures.
C) crowding out depends on the nature of spending done by the government.
D) government expenditures, on infrastructure and capital are more likely to lead to crowding in
because they expand a nation’s capital stock.
Difficulty: Medium
139. According to Professor Baotai Wang who examined the crowding out phenomenon in Canada between 1961–2000, as discussed in the Case in Point, which of the following categories of government expenditures are most likely to lead to crowding out?
A) expenditures for health and education
B) expenditures for infrastructure and capital
C) expenditures for the protection of persons and property, including defense spending
D) expenditures for government and social services
Difficulty: Medium
140.According to Professor Baotai Wang who examined the crowding out phenomenon in
Canada between 1961–2000, as discussed in the Case in Point, government expenditures for health and education
A) increased human capital and encouraged private sector investment, leading to crowding in.
B) did not increase the rate of return on private investment and therefore led to crowding out.
C) increased human capital and generated strong supply-side effects.
D) led to only small increases in human capital.
Difficulty: Medium
141.According to Professor Baotai Wang who examined the crowding out phenomenon in
Canada between 1961–2000, as discussed in the Case in Point, expenditures for protection of persons and property
A) involve no crowding out.
B) may involve some crowding out, but they also stimulated private investment by firms winning
government contracts for defense purchases.
C) stimulate aggregate demand and aggregate supply.
D) may involve some crowding out, which is offset by the strong supply-side effects they generate.
Difficulty: Medium
True/False
1. In the United States, government purchases, as a percentage of real GDP, have generally declined since the 2001.
2. Personal income and payroll taxes are the largest sources of revenue for the federal
government.
3. Fiscal policy is concerned with government’s manipulation of taxing, spending, and the money supply to encourage full employment at stable prices.
4. An increase in business taxes is likely to reduce aggregate demand because of a decrease in private investment.
5. A reduction in tax rates may result in a short-term reduction in government revenues, but it
will also leave people with more disposable income.
6. Selling Treasury bonds to finance a federal deficit crowds out private investment by driving
interest rates down.
7. Automatic stabilizers tend to exaggerate the severity of business cycles.
8. Transfer payments tend to rise automatically during a recession and fall automatically during
an expansion.
9. Automatic stabilizers are an example of discretionary fiscal policy.
10. If the level of government expenditures is given, budget surpluses and deficits depend on tax
revenues, which tend to vary directly with GDP.
11. The national debt is the difference between current government expenditures and taxes.
12. The United States has, by far, the largest national debt as a percentage of its GDP among industrialized nations.
13. The provision of aid to an individual who is not required to provide anything in exchange is called a transfer payment.
14. When government expenditures exceed revenues there is a government budget deficit.
15. The use of government expenditures and taxes to influence the level of economic activity is called fiscal policy.
16. An automatic stabilizer tends to increase GDP when it is rising.
17. An inflationary gap may be eliminated using contractionary fiscal policy.
18. If there is a recessionary gap, the appropriate fiscal policy would be contractionary.
19. Personal income taxes and transfer payments are examples of automatic stabilizers.
20. Fiscal policy has a short implementation lag compared to monetary policy.
21. An expansionary fiscal policy increases a government budget deficit or reduces a government budget surplus.
22. A contractionary fiscal policy will reduce a government budget deficit or increase a government budget surplus and lower the quantity of bonds the government must sell.
23. An expansionary fiscal policy increases a government budget deficit or reduces a government budget surplus, increases borrowing by the Treasury, which will sell more bonds.
24. A contractionary fiscal policy will reduce a government budget deficit or increase a government budget surplus and reduce borrowing by the Treasury.
25. An expansionary fiscal policy will result in the Treasury selling more bonds, the price of bonds falling, and interest rates rising.
26. An expansionary fiscal policy will result in higher interest rates and will reduce private investment.
27. The impact of expansionary fiscal policy is weakened because of crowding out.
28. Expansionary fiscal policy leads to an increase in net exports, all other things unchanged.
29. Contractionary fiscal policy will lead to an increase in government borrowing.
30. Contractionary fiscal policy will lead to a fall in interest rates.
Short Answer
1. Suppose an economy has a recessionary gap.
a. Illustrate this using a graph with LRAS, SRAS, and AD curves. Identify the equilibrium price level, real GDP, and the output gap in your diagram. Be sure to label your diagram fully.
b. Identify two fiscal policy tools which may be used to eliminate the gap.
c. Explain in words how these tools will affect the aggregate demand, long-run aggregate supply, and short-run aggregate supply curves.
d. Incorporate into your graph, the relevant shifts in the curves that would take place when expansionary fiscal policy is used to eliminate the recessionary gap.
2. Suppose an economy has an inflationary gap.
a. Illustrate this using a graph with LRAS, SRAS, and AD curves. Identify the equilibrium price level, real GDP, and the output gap in your diagram. Be sure to label your diagram fully.
b. Identify two fiscal policy tools which may be used to eliminate the gap.
c. Explain in words how these tools will affect the aggregate demand, long-run aggregate supply, and short-run aggregate supply curves.
d. Incorporate into your graph, the relevant shifts in the curves that would take place when expansionary fiscal policy is used to eliminate the recessionary gap.
3. Explain the concept of supply-side economics. Could the reasoning behind this theory make it in any way more effective than demand-management policies? Could it be less effective? Why?
4. Both monetary policy and fiscal policy encounter the problems of lags. Discuss the kinds of
lags they encounter and the degree of difficulties they present to policymakers.
5. Discuss and explain the concepts of the federal deficit and the national debt. How statistically
significant are they for the United States as compared to other countries? Explain how the deficits and the debt arise.
6. What is crowding out? How will crowding out dampen the effectiveness of expansionary fiscal policy?