Question 1

Consider an economy whose households save 20% of increases in their income.If the government lowers its transfers by $100 billion,then the real GDP will:

Accepted Answer

A decrease in transfers means households have less disposable income which in turn decreases their consumption expenditure. Assuming a multiplier of 5, a decrease in transfers by $100 billion will decrease consumption expenditure by $500 billion ($100 billion x 5). Since savings rate is 20%, this implies that households will save $100 billion ($500 billion x 0.2) of the decrease in consumption expenditure. The decrease in consumption expenditure ($500 billion) minus the increase in savings ($100 billion) leads to a decrease in real GDP by $400 billion.

Question 2

If policy makers want to decrease real GDP by $100 billion and the marginal propensity to consume is 0.6,they should _____ transfer payments by _____ $40 billion.

Accepted Answer

To decrease real GDP by $100 billion, policy makers need to decrease aggregate demand by $100 billion. 
We know that: 
Change in Real GDP = Change in Aggregate Demand * Multiplier

Since the multiplier equals 1/(1-MPC), we can rearrange the formula to: 
Change in Aggregate Demand = Change in Real GDP * (1-MPC)

Plugging in the given values, we get: 
Change in Aggregate Demand = -$100 billion * (1-0.6) = -$40 billion

So, policy makers should decrease transfer payments by more than $40 billion, since transfer payments are only a portion of aggregate demand. Option D is the only choice that suggests a decrease in transfer payments and a corresponding decrease in aggregate demand that is more than $40 billion.

Question 3

If the marginal propensity to consume is 0.9,then the tax multiplier will be:

Accepted Answer

The tax multiplier can be calculated using the formula: Tax Multiplier = - MPC / (1 - MPC). If the MPC is 0.9, then the tax multiplier can be calculated as -0.9 / (1 - 0.9) = -9. This means that a $1 increase in taxes will lead to a $9 decrease in aggregate demand. Since the tax multiplier is negative, it indicates a contractionary effect on the economy. The tax multiplier is less than 10, making choice (C) the correct answer.

Question 4

A $100 million increase in government spending increases equilibrium GDP by:

Accepted Answer

According to the Keynesian multiplier effect, an increase in government spending leads to an increase in aggregate demand, which leads to an increase in equilibrium GDP. The size of the multiplier depends on the economy's marginal propensity to consume (MPC), which measures the increase in consumer spending due to an increase in income. Assuming an MPC of 0.8, the multiplier can be calculated as 1/(1-MPC) = 1/(1-0.8) = 5. This means that a $100 million increase in government spending will lead to a $500 million increase in equilibrium GDP (5 x $100 million). Therefore, the answer is B, more than $100 million.

Question 5

The multiplier effect of changes in government purchases of goods and services is equal to:

Accepted Answer

The multiplier effect of changes in government purchases of goods and services is equal to 1 / (1 - MPC), where MPC is the marginal propensity to consume. This is because an increase in government purchases leads to an increase in income, which in turn leads to an increase in consumption. The size of this multiplier effect depends on the MPC, which is the fraction of additional income that is spent on consumption. Therefore, choice B is the correct answer.

Question 6

If the marginal propensity to consume is 0.75 and transfer payments increase by $30 billion,real GDP will:

Accepted Answer

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Question 7

If the marginal propensity to consume is 0.75 and government purchases of goods and services decrease by $30 billion,real GDP will:

Accepted Answer

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Question 8

If the marginal propensity to consume is 0.75 and taxes increase by $30 billion,real GDP will:

Accepted Answer

The formula to calculate the change in real GDP due to a change in taxes is:

∆GDP = (- MPC / (1 - MPC)) x ∆T

where MPC is the marginal propensity to consume and ∆T is the change in taxes.

Substituting MPC = 0.75 and ∆T = $30 billion, we get:

∆GDP = (- 0.75 / (1 - 0.75)) x $30 billion = (- 0.75 / 0.25) x $30 billion = - 3 x $30 billion = -$90 billion

Since the result is negative, it means that real GDP will decrease. The magnitude of the decrease is $90 billion, which is less than $120 billion. Therefore, the correct answer is C.

Question 9

Suppose the marginal propensity to consume is 0.8 and the government cuts taxes by $40 billion.Real GDP will _____ by _____.

Accepted Answer

The marginal propensity to consume of 0.8 means that for every $1 increase in disposable income, consumption will increase by $0.80. With a tax cut of $40 billion, disposable income will increase by $40 billion. Thus, consumption will increase by 0.8 x $40 billion = $32 billion. Using the expenditure approach to GDP, we can see that the increase in consumption will raise GDP by a multiple of 1/1-0.8 = 5. Therefore, the increase in GDP will be $32 billion x 5 = $160 billion.

Question 10

A change in taxes shifts the aggregate demand curve by _____ than a change in government spending for goods and services and has a _____ effect on real GDP.

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Question 11

For a marginal propensity to consume of 0.9,the multiplier effect of an increase of $100 billion in government purchases of goods and services is larger than the multiplier effect of a tax cut of $100 billion because:

Accepted Answer

The multiplier effect of an increase in government purchases of goods and services will be larger than a tax cut with the same amount because the marginal propensity to consume is 0.9, meaning that out of every extra dollar earned, 90 cents will be spent. However, in the first round of spending from a tax cut, only a portion of it will be spent, while the rest will be saved. On the other hand, an increase in government purchases will result in the entire amount being spent in the first round, leading to a larger multiplier effect. Hence, option D is the correct answer.

Question 12

If the marginal propensity to save is 0.25,investment spending is $700 million,and the government increases its purchases of goods and services by $100 million,then real GDP increases by:

Accepted Answer

Given, 
Marginal propensity to save (MPS) = 0.25
Initial investment spending (I) = $700 million
Change in government purchases (G) = $100 million

Using the formula,
∆Y= (1/(1-MPC)) * ∆G

where, 
MPC = Marginal propensity to consume = 1- MPS

MPC = 1-0.25 
MPC = 0.75

∆Y= (1/(1-0.75)) * 100

∆Y = 4 * 100

∆Y = $400 million

Hence, real GDP increases by $400 million.

Question 13

Suppose that marginal propensity to consume is equal to 0.9 and the government increases its spending by $200 billion.This increase in spending is financed by a $200 billion increase in taxes.As a result of this,GDP will:

Accepted Answer

The marginal propensity to consume (MPC) of 0.9 means that for every additional dollar of disposable income, people will spend 90 cents and save 10 cents. When the government increases its spending by $200 billion, this will lead to an increase in aggregate demand. Assuming no other factors change, this increase in spending will lead to a proportional increase in GDP. However, the $200 billion increase in taxes will reduce disposable income, leading to a decrease in consumption spending. The net effect will depend on the size of the MPC and the size of the initial change in spending. In this case, since the MPC is high (0.9), the decrease in consumption spending will be relatively small, and the increase in government spending will dominate. Therefore, GDP will increase by $200 billion, which is equal to the initial increase in government spending.

Question 14

If policy makers want to increase real GDP by $100 billion and the marginal propensity to consume is 0.75,they should _____ taxes by _____.

Accepted Answer

The answer of If policy makers want to increase real...

Question 15

Assume that marginal propensity to consume is 0.8 and potential output is $800 billion.If the actual real GDP is $700 billion,_____ government spending by _____ would bring the economy to potential output.

Accepted Answer

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Question 16

If policy makers want to increase real GDP by $100 billion and the marginal propensity to consume is 0.75,they should _____ government purchases of goods and services by _____.

Accepted Answer

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Question 17

Suppose an economy is producing real GDP of $300 billion.The potential output is equal to $400 billion,and the marginal propensity to consume is equal to 0.80.The government should ____ taxes by _____ to bring the economy to potential output.

Accepted Answer

To bring the economy to potential output, the government needs to increase aggregate demand. Since the marginal propensity to consume is 0.80, the multiplier effect will be 5 (1/0.20 = 5). Therefore, to increase aggregate demand by $100 billion ($400 billion - $300 billion), the government needs to reduce taxes by $20 billion ($100 billion/5). Thus, the correct choice is to cut taxes by $25 billion, which is not one of the given options. The closest option is to cut taxes by $20 billion (choice D), which will be effective in increasing aggregate demand by $80 billion (4 x $20 billion), bringing the economy closer to potential output.

Question 18

A change in government transfers shifts the aggregate demand curve by _____ than a change in government spending for goods and services and has a _____ effect on real GDP.

Accepted Answer

A change in government transfers, such as welfare or unemployment benefits, has a smaller effect on aggregate demand compared to a change in government spending for goods and services because transfers may not directly affect spending behavior as individuals may choose to save some of the transfer income.

Additionally, transfers may have a smaller effect on real GDP because they do not directly contribute to the production of goods and services, unlike government spending for goods and services which may contribute to increased employment and production.

Question 19

If policy makers want to decrease real GDP by $100 billion and the marginal propensity to consume is 0.6,they should _____ government purchases of goods and services by _____.

Accepted Answer

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Question 20

If the marginal propensity to consume is 0.75,the multiplier for taxes and transfer payments is:

Accepted Answer

The answer of If the marginal propensity to consume is...

Quiz 13: Fiscal Policy

Consider an economy whose households save 20% of increases in their income.If the government lowers its transfers by $100 billion,then the real GDP will:

If policy makers want to decrease real GDP by $100 billion and the marginal propensity to consume is 0.6,they should _ transfer payments by _ $40 billion.

If the marginal propensity to consume is 0.9,then the tax multiplier will be:

A $100 million increase in government spending increases equilibrium GDP by:

The multiplier effect of changes in government purchases of goods and services is equal to:

If the marginal propensity to consume is 0.75 and transfer payments increase by $30 billion,real GDP will:

If the marginal propensity to consume is 0.75 and government purchases of goods and services decrease by $30 billion,real GDP will:

If the marginal propensity to consume is 0.75 and taxes increase by $30 billion,real GDP will:

Suppose the marginal propensity to consume is 0.8 and the government cuts taxes by $40 billion.Real GDP will _ by _.

A change in taxes shifts the aggregate demand curve by _ than a change in government spending for goods and services and has a _ effect on real GDP.

For a marginal propensity to consume of 0.9,the multiplier effect of an increase of $100 billion in government purchases of goods and services is larger than the multiplier effect of a tax cut of $100 billion because:

If the marginal propensity to save is 0.25,investment spending is $700 million,and the government increases its purchases of goods and services by $100 million,then real GDP increases by:

Suppose that marginal propensity to consume is equal to 0.9 and the government increases its spending by $200 billion.This increase in spending is financed by a $200 billion increase in taxes.As a result of this,GDP will:

If policy makers want to increase real GDP by $100 billion and the marginal propensity to consume is 0.75,they should _ taxes by _.

Assume that marginal propensity to consume is 0.8 and potential output is $800 billion.If the actual real GDP is $700 billion,_ government spending by _ would bring the economy to potential output.

If policy makers want to increase real GDP by $100 billion and the marginal propensity to consume is 0.75,they should _ government purchases of goods and services by _.

Suppose an economy is producing real GDP of $300 billion.The potential output is equal to $400 billion,and the marginal propensity to consume is equal to 0.80.The government should taxes by _ to bring the economy to potential output.

A change in government transfers shifts the aggregate demand curve by _ than a change in government spending for goods and services and has a _ effect on real GDP.

If policy makers want to decrease real GDP by $100 billion and the marginal propensity to consume is 0.6,they should _ government purchases of goods and services by _.

If the marginal propensity to consume is 0.75,the multiplier for taxes and transfer payments is: