chapter 12

What fiscal policy tools are used to shift the aggregate demand curve? government spending and interest rates taxes and interest rates government spending and taxes taxes and employment rates

government spending and taxes Explanation Fiscal policy is the use of government taxes and spending to alter macroeconomic outcomes.

If the multiplier is 5 and defense expenditures decrease by $40 million, aggregate demand decreases by a total of $8 million. $20 million. $40 million. $200 million.

$200 million.Correct Explanation Total aggregate spending change = Multiplier × Initial injection = 5 × $40 million = $200 million.

Assume a marginal propensity to consume of 0.6. The change in total spending for the economy as a result of a $10 billion new government spending injection would be $6 billion. $25 billion. $60 billion. $600 billion.

$25 billion. Explanation Total aggregate spending change = Multiplier × Initial injection = (1 / (1 − 0.6) × $10 billion = $25 billion.

Refer to the figure. Assuming aggregate demand is represented by AD1 and full employment output is $5.6 trillion per year, the economy confronts a real GDP gap of $0 per year. $400 billion per year. $800 billion per year. $560 billion per year.

$400 billion per year. Explanation Current output is $6.0 trillion per year while full employment output is $5.6 trillion per year. The difference between the two represents the real GDP gap.

Disposable Income ($ billions/year) 100 // 200 Total Consumption ($ billions/year) 80 // 155 Savings ($ billions/year) According to the table, what is saving at a disposable income of $200 billion per year? $0 per year $20 billion per year $22 billion per year $45 billion per year

$45 billion per year Explanation Disposable income of $200 billion minus total consumption of $155 billion equals $45 billion, or all disposable income that is not spent.

If the marginal propensity to save is 0.1 and government spending is raised by $5 billion, then total aggregate spending will rise by $500 million. $5 billion. $10 billion. $50 billion.

$50 billion.Correct Explanation Total aggregate spending change = Multiplier × Initial injection = (1 / 0.1) × $5 billion = $50 billion.

Refer to the figure. Assuming aggregate demand is represented by AD1 and full employment output is $5.6 trillion per year, the equilibrium level of income is $800 billion per year. $5.2 trillion per year. $5.6 trillion per year. $6.0 trillion per year.

$6.0 trillion per year.Correct Explanation Full employment is irrelevant here as the question asks for the current equilibrium. Current equilibrium is found at the intersection of AD1 and AS, or $6.0 trillion per year.

Income and Consumption Data Disposable Income ($ billions/year) 100 // 200 Total Consumption ($ billions/year) 80 // 155 Savings ($ billions/year) According to the table, what is the marginal propensity to consume? 0.60 0.75 0.80 0.85

0.75 Explanation The marginal propensity to consume is the fraction of additional income people spend. If consumption increases from $80 billion per year to $155 billion per year while disposable income rises from $100 billion per year to $200 billion per year, then the marginal propensity to consume is 0.75 ($75 billion / $100 billion).

The multiplier is equal to 1 − Marginal propensity to save. Marginal propensity to save ÷ Marginal propensity to consume. 1 ÷ Marginal propensity to save. 1 ÷ Marginal propensity to consume.

1 ÷ Marginal propensity to save.Correct Explanation The multiple by which an initial change in aggregate spending will alter total expenditure after an infinite number of spending cycles is given by 1 / (marginal propensity to save).

Which of the following is the correct formula for the marginal propensity to consume? 1 ÷ (1 − Marginal Propensity to Save) (Total Consumption) ÷ (Total Disposable Income) 1 − Marginal Propensity to Save (Change in Consumption) + (Change in Disposable Income)

1 − Marginal Propensity to Save Explanation The marginal propensity to consume tells us what portion of an extra dollar of income will be spent. The remaining portion will be saved. If each dollar is either spent or saved, then the marginal propensity to save and marginal propensity to consume must sum to one.

Income and Consumption Data Disposable Income ($ billions/year) 100 // 200 Total Consumption ($ billions/year) 80 // 155 Savings ($ billions/year) According to the table, what is the multiplier? 0.75 0.80 4.00 5.00

4.00 Explanation The marginal propensity to consume is 0.75 ($75 billion / $100 billion), and so the multiplier is 4 (1/ (1 − 0.75)).

According to Keynes, which of the following is always true at macro equilibrium? The economy achieves full employment. Aggregate demand is inadequate. Prices are at the appropriate level. Aggregate demand equals aggregate supply.

Aggregate demand equals aggregate supply.Correct Explanation Macroeconomic goals are fulfilled only if we get the right amount of aggregate demand.

The terrorist attacks in September 2001 reduced consumer confidence. Which of the following indicates the resulting change in the U.S. economy after 9/11? The economy moved up along the aggregate demand curve. The economy moved down along the aggregate demand curve. Aggregate demand shifted to the left. Aggregate demand shifted to the right.

Aggregate demand shifted to the left. Explanation When consumer confidence decreases, consumers will demand fewer goods and services, shifting the aggregate demand curve to the left.

Most of the countries in the world suffered long and deep losses of output and employment between 1930 and 1935, which meant fewer purchases of U.S. goods and services. Which of the following indicates the appropriate change in the U.S. economy as foreigners purchased fewer U.S. goods and services? Aggregate demand shifted to the left. Aggregate demand shifted to the right. The economy moved up along the aggregate demand curve. The economy moved down along the aggregate demand curve.

Aggregate demand shifted to the left. Explanation With fewer purchases of U.S. goods, aggregate demand shifted to the left as exports fell.

Between 1921 and 1927, the stock market's value more than doubled, adding billions of dollars to the wealth of U.S. households and businesses. Which of the following indicates the appropriate change in the U.S. economy as a result of this stock market boom? The economy moved up along the aggregate demand curve. The economy moved down along the aggregate demand curve. Aggregate demand shifted to the left. Aggregate demand shifted to the right.

Aggregate demand shifted to the right. Explanation With more money to spend and general feeling of being wealthier, aggregate demand increased and shifted to the right.

When the economy overheats, the government sometimes cools it down with higher taxes, spending reductions, and less money. Which of the following indicates the appropriate change in the U.S. economy after these types of government interventions? Aggregate demand shifts to the left. Aggregate demand shifts to the right. The economy moves up along the aggregate demand curve. The economy moves down along the aggregate demand curve.

Aggregate demand shifts to the left. Explanation With these policies, people become cautious about spending and/or have less money to spend. Aggregate demand will then decrease as a result.

Which of the following is true about Keynes? He focused primarily on reducing inflation by shifting aggregate supply. He was a classical economist and prescribed a policy of laissez faire. He believed aggregate demand could be inadequate to ensure full employment. He was opposed to government intervention in the economy.

He believed aggregate demand could be inadequate to ensure full employment. Explanation Aggregate demand is typically at the wrong level to ensure full employment.

If the value of the dollar plummets in international currency markets, initially this causes foreigners to buy more American goods. Which of the following indicates the appropriate change in the U.S. economy from the dollar become less valuable? The economy moves up along the aggregate demand curve. The economy moves down along the aggregate demand curve. Aggregate demand shifts to the left. Aggregate demand shifts to the right.

Aggregate demand shifts to the right. Explanation If the value of the dollar falls, foreigners are able to purchase more American imports at lower prices than they could in their countries. This will increase exports. At the same time, if the dollar decreases in value, American consumers will be less able to buy foreign goods which will decrease imports. Both of these effects generate an increase in the aggregate demand curve.

Which of the following defines the composition of aggregate demand? C+ I + G C+ I + G + X C + I + G + (X-IM) C + I + G + IM

C + I + G + (X-IM)

_______ is expenditures by consumers on final goods and services.

Consumption

Which of the following economies has the largest multiplier? Economy A with a marginal propensity to save of 0.5 Economy B with a marginal propensity to save of 0.1 Economy C with a marginal propensity to consume of 0.8 Economy D with a marginal propensity to consume of 0.6

Economy B with a marginal propensity to save of 0.1 Explanation The marginal propensity to save is 0.1, therefore economy B has the greatest propensity to consume with a multiplier of 10 (1 / 0.1).

Which of the following is consistent with what Keynes believed? Markets automatically self-adjust to full employment very quickly. The economy is inherently stable. Monetary policy should be used to shift the aggregate supply curve. Fiscal policy should be used to shift the aggregate demand curve when aggregate demand is not at the appropriate level.

Fiscal policy should be used to shift the aggregate demand curve when aggregate demand is not at the appropriate level. Explanation The use of government spending and taxes to adjust aggregate demand is the essence of fiscal policy.

Which of the following helps explain the multiplier effect? Income is spent and re-spent in the circular flow model. People buy a lot of luxury items. Incomes tend to increase with inflation. Banks only hold a fraction of their deposits on reserve.

Income is spent and re-spent in the circular flow model. Explanation As a result of this multiplier process, aggregate demand increases by much more than the initial increase in government spending.

Which of the following is a fiscal policy prescription for ending a recession? Raise taxes to pay for greater transfer payments to stimulate the economy. Increase government expenditures to let the multiplier work. Raise interest rates to stimulate saving. Restrict exports to increase injections in the domestic economy.

Increase government expenditures to let the multiplier work. Explanation When the government increases its spending, it creates additional income for market participants.

All of the following represent government spending as a part of aggregate demand except for flood control national parks police and fire protection Social Security checks

Social Security checks Explanation Social Security is a transfer payment and is not classified as government spending.

Which of the following is the appropriate fiscal policy during a recession? a budget surplus a budget deficit a balanced budget no change to the budget

a budget deficit Explanation Whenever government expenditures exceed tax revenues a budget deficit exists. If the government cuts taxes and raises spending appropriately during a recession, it will generate a budget deficit. Balancing a budget or trying to generate a budget surplus would make the situation worse.

Which of the following could cause a recession? a decline in aggregate demand a decline in unemployment An increase in aggregate supply An increase in government spending

a decline in aggregate demand Explanation Recessions occur when aggregate demand declines and persist when aggregate demand remains below the economy's capacity to produce.

Refer to the figure. Which fiscal policy action would increase aggregate demand from AD1 to AD2, ceteris paribus? a decrease in transfer payments a decrease in taxes a decrease in government spending an increase in saving

a decrease in taxes Explanation A decrease in taxes would provide more disposable income to consumers, which would increase aggregate demand as consumer spending rose.

Ceteris paribus, _______ in consumer confidence will cause _______ in aggregate demand. a decrease; a decrease a decrease; no change an increase; a decrease an increase; no change

a decrease; a decrease Explanation Because consumption is a component of aggregate demand, if consumption falls due to lower confidence, aggregate demand will decrease as well.

When aggregate demand exceeds the full employment level of output, the result is significant unemployment. higher inventory levels. a higher average price level. a recession.

a higher average price level. Explanation Prices will rise due to shortages of output relative to demand increases.

Ceteris paribus, a decrease in exports will generate which of the following changes for aggregate demand? a rightward shift of the curve a leftward shift of the curve an upward movement along the curve a downward movement along the curve

a leftward shift of the curve Explanation A leftward shift demonstrates the effect of a decline in exports as this would mean less spending on domestically-produced goods and services.

Inflation occurs when aggregate demand increases faster than unemployment. unemployment increases faster than the labor force. aggregate demand increases faster than output. output increases faster than unemployment.

aggregate demand increases faster than output. Explanation If aggregate demand increases faster than output, average prices tend to rise.

If an economy has a GDP gap such that equilibrium output is less than full employment output, which of the following is a correct fiscal policy action? a reduction in Social Security payments an increase in the money supply an increase in government expenditures an increase in the tax rate

an increase in government expenditures Explanation The simplest solution to the demand shortfall would be to increase government spending through fiscal stimulus.

Which of the following is an example of fiscal stimulus? an increase in government spending on new military jet fighters an increase in consumption because of improved consumer confidence an increase in personal income taxes for families with children an increase in the purchase of office buildings by foreign investors

an increase in government spending on new military jet fighters Explanation Fiscal stimulus is an increase to government spending (or decrease to government taxes) specifically.

Refer to the figure. Assume aggregate demand is represented by AD2. Which of the following could cause a shift to AD3? an increase in government spending on goods and services an increase in consumer spending an increase in taxes an increase in investment spending

an increase in taxesCorrect Explanation An increase in taxes reduces consumer disposable income and so aggregate demand will fall as consumer spending declines.

A tax cut of $8 billion with a marginal propensity to consume of 0.90 will cause a cumulative change in spending equal to an increase of $720 million. an increase of $72 billion. an increase of $80 billion. a decrease of $720 billion.

an increase of $72 billion. Explanation Total aggregate spending change = Multiplier * Initial injection. Because consumers will save a portion of the tax cut, not all $8 billion enters the economy as an injection, only $7.2 billion will ($8 billion × 0.9). Therefore: Total aggregate spending change = (1 / (1 − 0.9) × $7.2 billion = $72 billion.

If aggregate supply is upward sloping, fiscal stimulus causes _______ in aggregate demand and _______ in prices. a decrease; a decrease a decrease; an increase an increase; a decrease an increase; an increase

an increase; an increaseCorrect Explanation Whenever the aggregate supply curve is upward sloping, an increase in aggregate demand increases prices as well as output

According to Keynes, an unbalanced budget was very appropriate at certain times. an unbalanced budget was appropriate during a full-employment equilibrium. a budget deficit was appropriate most of the time. tax cuts were always appropriate because of their political appeal.

an unbalanced budget was very appropriate at certain times. Explanation An unbalanced budget is perfectly appropriate if macro conditions call for a deficit or surplus.

In economics, investment refers to: the sale of stocks and bonds in the secondary market improvements to the public infrastructure purchases of stocks and bonds business spending on plant and equipment

business spending on plant and equipment

The component of aggregate demand that contributes most to total spending is _______ spending.

consumption

The four components of aggregate demand are net exports, income, interest, and investment. consumption, investment, government spending, and net exports. consumption, interest, and government spending. net exports, government spending, investment, and foreign trade.

consumption, investment, government spending, and net exports. Explanation The four major components of aggregate demand are consumption, investment, government spending, and net exports.

Ceteris paribus, if the government transfers income from individuals with a high marginal propensity to consume to those with a low marginal propensity to consume, in the short run, spending and output will increase. decrease. stay the same. increase or decrease depending on the level of saving.

decrease. Explanation Those with low propensity to consume may save more thus decreasing spending and output.

If the economy is experiencing inflation, which of the following is most likely to decrease aggregate demand? increasing spending and cutting taxes increasing spending and raising taxes decreasing spending and cutting taxes decreasing spending and raising taxes

decreasing spending and raising taxesCorrect Explanation People will pay higher taxes and reduce their consumption while the government also spends less money directly. Both of these would generate a decrease in aggregate demand.

The purpose of fiscal stimulus is to shift aggregate demand to the left. demand to the right. supply to the left. supply to the right.

demand to the right. Explanation Tax cuts or spending hikes intended to increase aggregate demand (shift to the right). Increased government spending would add directly to aggregate demand while tax cuts add indirectly to aggregate demand as consumers and firms have more disposable income to spend.

The after-tax income of consumers is defined as consumption. disposable income. personal income. savings.

disposable income. Explanation The money left after taxes is disposable income.

Fiscal stimulus is most effective in changing the level of real output without causing inflation when the aggregate supply curve is horizontal. vertical. upward sloping to the right. downward sloping to the right.

horizontal. Explanation Only if the aggregate supply curve were horizontal would there be no risk of inflation.

All of the following represent government spending as a part of aggregate demand except for federal government spending on roads. state and local government spending on schools. income transfers. national defense.

income transfers. Explanation Government spending only accounts for money the government spends on goods and services since aggregate demand captures spending on output. Income transfers are payments to individuals for which no services are exchanged and so are not included in either government spending or aggregate demand.

If the current level of spending falls short of full employment, the government can close the GDP gap by increasing government spending by an amount less than the GDP gap. increasing government spending by an amount greater than the GDP gap. decreasing government spending by an amount less than the GDP gap. decreasing government spending by an amount greater than the GDP gap.

increasing government spending by an amount less than the GDP gap. Explanation This will shift aggregate demand to the right.

Which of the following will occur if aggregate demand is above full employment GDP? recession high unemployment inflation a stable economy

inflation Explanation The scramble for available goods and services pushes prices up as demand will rise faster than output.

A budget deficit occurs if government spending equals tax revenues. is greater than tax revenues. is less than tax revenues. causes tax revenues to increase.

is greater than tax revenues. Explanation If the government spends more than it collects in taxes, a budget deficit occurs.

Which of the following will definitely reduce a budget deficit and provide fiscal restraint? greater government spending and lower taxes greater government spending and higher taxes lower government spending and lower taxes lower government spending and higher taxes

lower government spending and higher taxes Explanation The government must reduce spending and increase taxes to make the budget balance more positive.

If consumers spend 79 cents out of every extra dollar received, the multiplier is 0.79. marginal propensity to consume is 0.79. marginal propensity to save is 0.79. marginal propensity to consume is 0.21.

marginal propensity to consume is 0.79. Explanation The marginal propensity to consume is 0.79 of every dollar.

If consumers spend 75 cents out of every extra dollar received, the marginal propensity to save is 0.75. marginal propensity to consume is 0.25. multiplier is 4. multiplier is 7.5.

multiplier is 4. Explanation The multiplier is 1÷ (1 − 0.75) = 4.

If the federal government uses its budget to shift aggregate demand in an attempt to manage the macroeconomy, it is likely that the budget will always be balanced. always be in a deficit. always be in a surplus. often be unbalanced.

often be unbalanced Explanation By reducing/increasing tax revenues and increasing/decreasing expenditures simultaneously, the federal government will likely throw its budget out of balance.

Which of the following will occur if aggregate demand is below full employment GDP? recession excessive aggregate demand inflation a stable economy

recession Explanation Less spending is generated when the economy is below full employment.

During an inflationary period, it is appropriate for the government to pursue policies that stimulate aggregate demand. reduce aggregate demand. make budget deficits larger. eliminate the public debt.

reduce aggregate demand. Explanation If excessive aggregate demand is causing prices to rise, the goal of fiscal policy will be to reduce aggregate demand, not stimulate it.

In a graph of the aggregate demand curve, an increase in investment by businesses is represented by a movement down the curve. movement up the curve. rightward shift of the curve. leftward shift of the curve.

rightward shift of the curve. Explanation Because investment is a component of aggregate demand, increases to investment will cause aggregate demand to rise as well.

With respect to the aggregate demand curve, a tax cut will move the economy down along the curve. move the economy up along the curve. shift the curve leftward. shift the curve rightward.

shift the curve rightward. Explanation Aggregate demand will increase as consumers have more money to spend and so it will shift to the right.

Fiscal policy is the use of government _______ and _______ to alter macroeconomic outcomes.

spending; taxes

An improvement in consumer confidence will cause a movement down the aggregate demand curve. the aggregate supply curve to shift to the right. the aggregate demand curve to shift to the right. the aggregate demand curve to shift to the left.

the aggregate demand curve to shift to the right. Explanation When consumers have more confidence, they will buy more output at all price levels.

The GDP gap is the difference between equilibrium output and full employment output. the amount of output at the ideal price level equal to the difference between imports and exports equal to the multiplier

the difference between equilibrium output and full employment output. Explanation A GDP gap is the difference between full employment output and the current equilibrium level of output.

The marginal propensity to consume is total consumption in a given period divided by total disposable income. the percentage of total disposable income spent on consumption. that part of the average consumer dollar that goes to the purchase of final goods. the fraction of each additional dollar of disposable income spent on consumption.

the fraction of each additional dollar of disposable income spent on consumption. Explanation The marginal propensity to consume is the fraction of each dollar of disposable income spent on consumption.

Which of the following is NOT an example of investment spending? construction of a new factory the purchase of stock in the stock market inventory expenditures new equipment

the purchase of stock in the stock market Explanation The purchase of stock is not an economic investment. In fact, stock purchases by investors are often used to finance investment spending.