fiscal policy tutorial

8/11/2019 Fiscal Policy Tutorial

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Multiple Choice Tutorial

Chapter 7F iscal Policy


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1. Fiscal policy

a. uses the federal governments power of

spending and taxation to affectemployment, price levels, and GDP

b. uses the federal governments power overthe money supply and interest rates to

affect employment, the price level, and GDPc. can affect employment and price, but not

the level of GDP

A. Fiscal policies are policies of the federalgovernment to influence demand. Duringperiods of inflation we would want demand todecrease, during periods of unemployment

we would want demand to increase.


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3. John M. Keynes is best known for advocating

a. a policy of annually balancing the budget.

b. deficit spending during some recessions.c. the fixed-growth-rate monetary rule.B. Before the Great Depression of the 1930s

Classical economics was the accepted believe.

According the Classical thinking, theeconomy was always tending toward a fullemployment equilibrium, therefore there wasno need for government intervention. Keynes

believed that the economy could tend towarda less then full employment equilibrium,therefore, in this case, there was need forgovernment intervention to move the

economy to a full employment equilibrium.


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4. If government purchases of good and servicesincrease by $10 billion when the MPC is .8

and the MPS is therefore .2, thena. real GDP will increase by $16 billion

b. real GDP will increase by $20 billion

c. real GDP will increase by $40 billion

d. real GDP will increase by $50 billion

D. The formula for the multiplier is 1/MPS.Because the MPS is 2/10, which equals 1/5,

the multiplier is equal to 1 divided by 1/5 or5. Now take the multiplier and multiply it bythe spending increase and you get 5 x $10bil l ion = $50 bil l ion.


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5. When automatic stabilizers kick in topartially counteract recessionary forces

a. aggregate demand rises above its pre-recession level.

b. the deficit falls below its pre-recessionlevel.

c. the government tends to have more of adeficit, which is intended to stimulate theeconomy.

C. An example of an automatic stabilizer is

unemployment benefits. During recessionsthe economy experiences insufficientaggregate demand, the unemploymentbenefits help to increase aggregate demand.


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6. The balanced budget multipliera. is greater than 1.

b. is less than 1.

c. is equal to 1.

d. can be more or less than 1.

C. It is equal to one because the amount ofthe tax increase is the same is the extra

amount the government spends.


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7. Lets say inflation remains stable and hugegovernment budget deficits drive up marketinterest rates. This will cause

a. foreign investment in the U.S. to increase.

b. imports to decrease.

c. the foreign trade deficit to decrease.

d. the value of the dollar to depreciaterelative to foreign currencies.

A. As interest rates in America increase relativeto interests rates in foreign countries,everything else remaining the same, will giveforeigners an incentive to put their money inAmerica to take advantage of the favorableinterest rates.


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8. Which of the following steps does notbelong ina sequence reflecting the impact oninternational markets of increased borrowing?

a. the U.S. Treasury sells securities.

b. the sale of securities drives up interest rates.

c. the rising value of the dollar leads to

increased U.S. exports and reduced imports.C. Higher interest rates in America will attract

foreign investment. But to invest in America,foreigners need American dollars, thus the

demand for dollars increases in the worldmarket, increasing the dollars value. Foreignproducts are now less expensive to Americansand American products more expensive to

foreigners.


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9. Which of the following would neutralize andoffset the stimulating effect of deficit spending?

a. increased saving

b. increased investment spending

c. increased personal consumption

expendituresd. a decrease in taxes

A. The more people can save, the lessdependant they will be on the governmentwhen they retire.


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10. All of the following are variables that can bemanipulated to affect fiscal policy except

a. personal income taxes

b. government expenditures on goods andservices

c. government expenditures onunemployment benefits

d. the rate of interest

D. A change in interest rates are influenced bythe Federal Reserve. The Feds ability toincrease or decrease the nations moneysupply gives it some influence as to whathappens to interest rates.


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11. A $100 billion dollar increase in governmentspending increases real GDP more than a$100 billion reduction in net taxes because

a. some of the dollars consumers gain fromthe tax reduction will be savedb. some of the dollars consumers gain from

the tax reduction will be spent on servicesc. consumers will spend some of it on foreign

goodsA. The multiple effect is greater when the

government has the $100 billion because itwill spend all of it - if citizens have themoney, they will save a portion of it -depending on the Marginal Propensity to

Consume (MPS)


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12. When the MPC is .75, a decrease in net taxesof $100 billion will increase the equilibriumlevel of real GDP by

a. $75 billion

b. $100 billion

c. $300 billion

C. -MPC/(1-MPC) = -.75/.25 = -3; -3 x -$100

billion = $300 billion


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13. The effect of a change in net taxes on thequantity of real GDP demanded equals the

resulting shift in the consumption functiontimes

a. the marginal propensity to consume

b. the marginal propensity to save

c. the autonomous net tax multiplier

C. The autonomous net tax multiplier is theratio of a change in equilibrium real GDP

demanded to the initial change inautonomous net taxes that brought it about;the numerical value of the multiplier is-MPC/(1-MPC).


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14. When net taxes and government purchasesare reduced by the same amount

a. there will be an increase in real GDP equalto the size of the reduction

b. there will be a decrease in real GDP equalto the size of the reduction

c. there will be an increase in real GDP thatdepends upon the size of the multiplier

d. there will be a decrease in the real GDPdepending on the size of the multiplier

D. The multiplier works in reverse. If there is areduction of X amount of spending, real GDPwill decrease by a multiple of that decrease.


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15. Which of the following is an example offiscal policy?

a. the Federal Reserve Board reduces interestrates

b. the local school board raises teacherssalaries

c. General Electronics Corp. borrows $100million to build anew factory

d. the federal government reduces personalincome tax rates

D. Fiscal policies are policies of the federalgovernment for the purpose of increasing ordecreasing aggregate demand to fight eitherunemployment or inflation.


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16. All of the following are components of theaggregate expenditure function which may be

examples of fiscal policy excepta. government expenditure for social security

b. consumption expenditure for appliances

c. investment expenditures for capital

equipmentd. government expenditures for highway

construction

A. Government spending on Social Security issimply a transfer payment; money is takenfrom one group and given to another group.


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17. All of the following might be effective ineliminating a contractionary gap except

a. reducing Social Security payments tobeneficiaries.

b. reducing personal income taxes.

c. increasing expenditures for the interstate

highway system.d. increasing farm subsidies.

A. First of all, reducing Social Security

benefits would not be used as a fiscalpolicy. Second, even if we did reduce thebenefits, this would depress the economyand not stimulate it as would be needed tocorrect a contractionary gap.


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18. When there is a contractionary gap, effectivefiscal policy might be to

a. reduce market prices

b. reduce interest rates

c. increase the money supply

d. increase government purchases

D. All of the above would help when we are in aless than full employment equilibrium; but

only an increase in government purchases is afiscal policy, the others are monetary policies.


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19. When fiscal policy is effective in eliminatinga contractionary gap it

a. increases potential GDPb. increases the equilibrium level of real GDP

c. increases the rate of unemployment

d. decreases the level of prices

B. Fiscal policies differ from monetary policesin that they can shift the equilibrium. With aContractionary gap present the economy is

tending toward a point of less than fullemployment. By shifting aggregate demandupward, the intent is to move the equilibriumto a full employment equilibrium.


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20. An appropriate fiscal policy to deal with anexpansionary gap is to

a. increase the rate of interest.

b. increase farm subsidy payments.

c. increase government purchases.

d. increase personal taxes.

D. An expansionary gap would exist when we

have inflation. An increase in personal taxeswould decrease taxpayers disposable income.With the resultant decrease in demand,prices would decline.


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21. When there is an expansionary gap, effectivefiscal policy might include all of the followingexcept

a. increasing personal taxes

b. increasing corporate taxes

c. increasing aggregate supply

d. decreasing government purchasesC. With an Expansionary gap the economy is

overheated. So we want to cool it down bylowering aggregate demand. Increasingpersonal taxes, increasing corporate taxes,and decreasing government purchases lowersaggregate demand. Increasing aggregatesupply heats the economy up.


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22. When the aggregate supply (AS) curve has apositive slope, effective fiscal policy to correctfor an expansionary gap willa. only reduce prices.

b. only reduce real GDP.

c. only increase prices.d. reduce both prices and real GDP.

D. Simply draw this out on a piece of paper.With an up-sloping curve and a down-slopingdemand curve, a shift to the left of thedemand curve will bring about a decrease inprices (vertical axis) and an decrease in realGDP (horizontal axis).


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23. John M. Keynes influenced the use of fiscalpolicy in the U.S. by arguing effectively that

a. that balancing the national budget at alltimes was sound economic policy

b. national economic forces were notnecessarily adequate to move the economy

towards its potential output levelc. the government did not need to stimulate

output in order for the economy to achieveits potential output level

B. The biggest difference between Keynes andthe Classical economists was that Keynesbelieved that the economy could tend towarda point of less than full employment.


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24. Prior to the Great Depression of the 1930s,the dominant fiscal policy was

a. to lower taxes whenever unemploymentbegan to increase

b. to increase government purchaseswhenever the nations output fell below its

potential output levelc. to raise taxes or reduce governmentpurchases whenever necessary to balancethe federal budget

C. The Classical economists did not believe infiscal policies to stimulate the economy duringperiods of recession. However, they did believethat it was fiscally sound for the federal

government to have a balanced budget.


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25. Which of the following is the best example ofan automatic stabilizer in fiscal policy?

a. spending more on national highways

b. paying pensions to retired militarypersonnel

c. paying unemployment insurance benefitsd. decreasing the supply of money

C. Automatic stabilizers go into effect during

periods of unemployment and cease when theeconomy recovers. Only the payment ofunemployment benefits in the above choicesfits this description.


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26. Automatic stabilizers

a. have no effect on unemployment levelsb. have no effect on output levels

c. increase the size of the expansionary gap

d. reduce the magnitude of economic

fluctuations

D. Automatic stabilizers do not totally reverse adecline in aggregate demand (for this to

happen the payments would have to equal allof a persons loss of income), but they do slowdown the downward trend.


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28. Which of the following is the best example ofanti-recession discretionary fiscal policy?

a. increase in government expenditures onpublic construction projects like bridges,dams, and roads

b. a decrease in taxes on liquor and

cigarettesc. a decrease in welfare payments

A. Discretionary fiscal policies differ fromautomatic stabilizers in that they are not

automatic, but are up to the discretion ofCongress. When the government increasesspending, it is best to spend it on building ourinfrastructure, like roads and bridges.


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30. Which one of the following is not one of theconcerns most often expressed about the

effectiveness of fiscal policy?a. the difficulty of estimating the natural rateof unemployment.

b. the time lags involved in implementing

fiscal policy.c. an increase in aggregate demand tends to

worsen unemployment.

C. An increase in aggregate demand will causean increase in employment.


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31. Stagflation is defined as the double troubleof higher inflation combined with an increaseina. the money supply

b. unemployment

c. the price leveld. corporate profits

B. With stagflation the economy is stagnating

and inflating at the same time.


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32. The rate of unemployment that occurs whenthe economy is producing its potential GDP

a. is called the natural rate of unemployment.

b. is naturally zero.

c. is thought to be approximately 10%.

d. is equal to the rate of stagflation in mostyears.

A. The natural rate of unemployment equalsfull employment. If, lets say, five percent ofthe labor force would be looking for workeven in the best of times, then five percent orless of unemployment would be consideredfull employment.


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33. Which of the following does not hamper theeffectiveness of discretionary fiscal policy?

a. the difficulty of estimating the natural rateof unemployment

b. time lags involved in enacting appropriatelegislation

c. the difficulty of getting an accuratemeasure of the rate of inflation

d. time lags involved in recognizing the needfor fiscal policy

C. Discretionary fiscal policies would be usedmore for unemployment and not inflation.Even if they were used for inflation, we haveno difficulty in measuring the inflation rate.


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34. People will be likely to spend a higherpercentage of any additional income when

a. they believe that the increase is permanent.b. they believe that the increase is temporary.

c. the increase is large.

d. the increase is small.

A. One of the failings of discretionary fiscalpolicies is that they can bring about changesthat consumers will view as temporary and

not permanent. It has been shown that peoplewill base their spending habits more on whatthey consider their permanent income andless so on their perceived temporary income.


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35. A temporary tax increase imposed in 1986for an 18 month period failed to reduceconsumption expenditures in the U.S. by theamount expected because

a. people viewed the tax increase aspermanent.

b. people viewed the tax increase astemporary.

c. people chose to increase their saving.

d. consumption expenditures are unrelated to

the level of taxation.B. This is an example of a fiscal policy that was

not effective because it was perceived astemporary and not permanent.


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36. Changes in discretionary fiscal policy (e.g.,taxes) and automatic stabilizers (e.g.,unemployment insurance benefits) can havesignificant unintended effects on all of thefollowing except

a. the incentive to work.

b. the incentive to spend.c. the incentive to save.

d. the incentive to purchase imported goods.

D. Whether people purchase imported goods ornot has nothing to do with discretionary fiscalpolicies.


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37. Raising taxes as an element of discretionaryfiscal policy is intended to reduce aggregatedemand, but it can also reduce aggregatesupply if

a. the higher taxes lead workers to seek out asecond job.

b. the higher taxes cause workers to workless.

c. the government purchases goods with theadditional revenue.

B. With an increase in taxes tax-payersdisposable income decreases. If they use theirdisposable income as a measure of if theyshould work or not, workers will work less.


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38. President Reagan and the U.S. Congressagreed on substantial changes in the federal

budget in the early 1980s. Among thesechanges was

a. a decrease in defense spending.

b. a 3% tax reduction.c. a 13% tax reduction.

d. a 23% tax reduction.

D. We had the largest tax decrease in historyunder President Reagan. The big taxdecreases in the early 1980s contributedgreatly to the prosperity of the 1990s.


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39. The lower tax rates enacted in the early1980s were intended to

a. increase the supply of labor.

b. increase the price level.

c. increase unemployment benefits.

d. reduce potential GDP.

A. This is what is called supply sideeconomics. By lowering taxes, people willmore of an incentive to work and invest.

40 Th R i t i l id


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40. The Reagan experiment in supply-sideeconomics resulted in all of the followingexcept

a. growth in employment.b. a period of sustained economic growth.

c. a reduction in the federal debt.

C. In the long run, a decrease in taxes will leadto an increase in real GDP do to the increasein economic growth. However, in the shortrun, this decrease in taxes will decrease

government tax revenue and therefore add tothe national debt, assuming no decrease ingovernment spending. Government spendingactually increased under Reagan because of

big increases in military spending.


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41. Large federal budget deficits

a. can best be reduced by discretionary fiscal

policy.b. make it difficult to use discretionary fiscal

policy.

c. in the mid to late 1980s were the result of a

severe recession.d. still constitute only about 1% of the GDP.

B. Large deficits make it difficult for

discretionary fiscal policy because the lowertaxes and/or increases in governmentspending can add to the national debt.


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42. The idea that non-inflationary economicgrowth can be induced by governmentprograms designed to increase production and

labor effort is called

a. the balanced budget multiplier.

b. the feedback effect.

c. an automatic stabilizer.d. supply side economics.

D. Keynesian economics stresses a reliance onthe demand side of the equation. Supply sideeconomics dwells on the supply side of theequation. A decrease in costs will move theaggregate supply curve to the right, thusprices decline and real GDP increases.


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