Question 1

To combat a recession, fiscal policy should move toward a budget that is

Accepted Answer

To combat a recession, fiscal policy typically involves increasing government spending and decreasing taxes, which moves the budget toward a deficit. This is intended to stimulate economic activity by increasing demand.

Question 2

To combat inflation, fiscal policy should move toward a

Accepted Answer

To combat inflation, fiscal policy should move towards a budget surplus. This approach involves the government collecting more in taxes than it spends, which can help to reduce the total amount of spending in the economy, thereby helping to control inflation.

Question 3

To combat a recession, the correct fiscal policy would be a

Accepted Answer

To combat a recession, the correct fiscal policy involves stimulating economic activity. This can be achieved by cutting taxes, which puts more money into consumers' hands, and increasing government spending, which injects money directly into the economy. Both measures are designed to increase demand. Running a budget deficit is often a consequence of these actions, as government expenditures exceed tax revenues.

Question 4

If the federal government implements public-works projects to combat downturns in the economy, this would be an example of

Accepted Answer

Discretionary fiscal policy involves deliberate government action to influence economic activity, such as implementing public-works projects to stimulate the economy during downturns. This contrasts with automatic stabilizers, which work without specific government intervention.

Question 5

Assume that the economy's marginal propensity to consume is 0.9 and the price level is constant. If the U.S. government purchases $10 billion of jet aircraft from American companies, aggregate demand will increase by

Accepted Answer

The multiplier effect is calculated as 1/(1-MPC). With an MPC of 0.9, the multiplier is 10. Therefore, a $10 billion increase in government purchases will increase aggregate demand by $10 billion * 10 = $100 billion.

Question 6

Which combination of fiscal policies would have the greatest expansionary effect on the economy?

Accepted Answer

Option B combines increasing government expenditures, which directly injects money into the economy, with decreasing personal income taxes and providing an investment tax credit, both of which increase disposable income and incentivize investment. This combination is the most likely to stimulate economic activity by boosting both demand (through higher disposable income) and supply (through increased investment).

Question 7

Suppose the economy is in a recession and that the marginal propensity to consume is 0.75. Assuming that the price level is constant, by how much would the government have to increase its expenditures in order to increase real output by $200 billion?

Accepted Answer

The government spending multiplier is calculated as 1/(1-MPC), which is 1/(1-0.75) = 4. To increase real output by $200 billion, the government needs to increase expenditures by $200 billion / 4 = $50 billion.

Question 8

Suppose the economy is in a recession and that the marginal propensity to consume is 0.8. Assuming that the price level is constant, by how much would government have to decrease household taxes in order to increase real output by $200 billion?

Accepted Answer

The marginal propensity to consume (MPC) is 0.8, which means for every dollar of income, consumption increases by 80 cents. To find out how much taxes need to be decreased to increase real output by $200 billion, we use the multiplier formula: 1/(1-MPC). Here, the multiplier is 1/(1-0.8) = 5. Therefore, to increase output by $200 billion, taxes need to be decreased by $200 billion / 5 = $40 billion. However, since the question asks for the increase in real output, and the decrease in taxes directly increases disposable income which then is multiplied through the economy, the correct calculation should consider how the initial increase in disposable income translates into a larger increase in real output due to the multiplier effect. Given the multiplier of 5, to achieve a $200 billion increase in real output, the initial increase in disposable income (or decrease in taxes) should be $200 billion / 5 = $40 billion. My initial explanation contained an error in interpreting the final step of the calculation. The correct answer is indeed to find the initial tax decrease required to achieve the desired increase in output, which, based on the multiplier effect, is $40 billion. This was a mistake in my explanation process. The correct calculation based on the given MPC and the desired increase in real output should lead to the conclusion that a smaller tax decrease is required to achieve the larger output increase due to the multiplier effect.

Question 9

If the aggregate supply curve is horizontal, an expansionary fiscal policy will result in increased output, along with

Accepted Answer

When the aggregate supply curve is horizontal, it indicates that the economy is not operating at full capacity and there is slack in the economy. In such a scenario, expansionary fiscal policy, which involves increasing government spending or decreasing taxes to stimulate the economy, will lead to higher employment as firms increase production to meet the higher demand. Prices remain stable because the economy has the capacity to meet the increased demand without putting upward pressure on prices.

Question 10

If the aggregate supply curve is upward sloping, the cost of using a contractionary fiscal policy to combat inflation will be

Accepted Answer

When the aggregate supply curve is upward sloping, contractionary fiscal policy, which aims to reduce inflation, can lead to decreased real output and employment as it reduces aggregate demand.

Question 11

The basic elements of fiscal policy were developed by

Accepted Answer

John Maynard Keynes is credited with developing the basic elements of fiscal policy during the Great Depression. His ideas emphasized the role of government spending and taxation in managing economic activity.

Question 12

The automatic fiscal stabilizers include all of the following except

Accepted Answer

The prime interest rate is not an automatic fiscal stabilizer because it is not a government program that automatically responds to changes in the economy.

Question 13

Unlike discretionary fiscal policy, automatic stabilizers consist of

Accepted Answer

Automatic stabilizers work without the need for new government action, adjusting government spending and tax revenues as economic conditions change, unlike discretionary fiscal policy which requires deliberate action.

Question 14

All of the following are problems of fiscal policy except

Accepted Answer

The singular-motion effect is not a recognized problem of fiscal policy. Problems of fiscal policy typically include recognition lags (time to identify a problem), administrative lags (time to implement policy), and the crowding-out effect (government borrowing leading to less private investment).

Question 15

Fiscal policy is enacted by the

Accepted Answer

Fiscal policy involves government spending and taxation decisions, which are determined by Congress and the president.

Question 16

The lag between the time that a recession is recognized and the time an expansionary fiscal policy is enacted is the

Accepted Answer

The administration lag refers to the delay between recognizing a recession and implementing an expansionary fiscal policy.

Question 17

The crowding-out effect occurs when increased government expenditures and the subsequent budget deficits cause

Accepted Answer

The crowding-out effect refers to a situation where increased government spending leads to higher interest rates. These higher rates make borrowing more expensive for businesses and consumers, which can reduce the level of private investment spending.

Question 18

Which of the following is not true for the crowding-out effect?

Accepted Answer

The crowding-out effect typically occurs when government spending increases interest rates, leading to reduced investment by the private sector. However, it is less likely to occur during a deep recession when there is a lot of unspent money in the economy and interest rates are likely already low to stimulate spending.

Question 19

When there is open international investment, an expansionary fiscal policy in the U.S. will

Accepted Answer

An expansionary fiscal policy in the U.S., such as increased government spending or tax cuts, typically leads to larger budget deficits. These deficits are financed by borrowing, which can attract foreign investment as the demand for U.S. securities increases, offering potentially higher returns to investors.

Question 20

The ratio of U.S. federal debt to GDP is

Accepted Answer

The answer of The ratio of U.S. federal debt to...

Quiz 13: Fiscal Policy and the Federal Budget