Econ 202 Chapter 16

Multiplier Effect

Process by which an increase in autonomous expenditure leads to a larger GDP Occurs when both auto expenditure increase and decreases Makes the economy more sensitive to changes in auto expenditure "The larger the MPC, the larger the value of the multiplier" Oversimplified because ignores real world complications such as the effect that increases in GDP have on imports, inflation, Interest rates, and individual income taxes

Broken Window Fallacy

The broken window fallacy states that when a window breaks and someone spends money to repair it, they have created new economic activity that would not have otherwise taken place.

Crowding-Out Effect

a rise in interest rates and a resulting decrease in planned investment caused by the federal governments increased borrowing in the money market

If (the absolute value of) the tax multiplier equal 1.6, real GDP is $13 trillion, and potential real GDP is $13.4 trillion, then taxes would need to be _____ to restore the economy to potential real GDP a) cut by $250 billion b) increases by $1.4 trillion c) cut by $1.4 trillion d) increased by $400 billion e) cut by $400 billion

a) cut by $250 billion

Decreasing government spending _____ the price level and _____ equilibrium real GDP in the short run. a) decreases; decreases b) decreases; increases c) increases; decreases d) increases; increases

a) decreases; decreases

Compare the time lags involved in stabilizing the economy using monetary and fiscal policy. Inside lags are likely longer for ____ policy and outside lags are likely longer for ____ policy. a) fiscal; monetary b) monetary; fiscal c) monetary; monetary d) fiscal; fiscal

a) fiscal; monetary

Tax reduction and simplification should ______ long-run aggregate supply and ______ aggregate demand. a) increase; increase b) decrees; decrease c) increase; decrease d) decrease; increase

a) increase; increase

An increase in government spending causes money demand to ______, which causes interest rates to _____, which causes investment spending to _____. This is known as "crowding out." a) increase; increase; decrease b) increase; increase; increase c) decrease; decrease; increase d) decrease; decrease; decrease e) none of the above are correct

a) increase; increase; decrease

If (the absolute value of) the tax multiplier equals 1.6, real GDP is $13.8 trillion, and potential real GDP is $13.4 trillion, then taxes would need to be ________ to restore the economy to potential real GDP. a) increased by $250 billion b) cut by $400 billion c) cut by $250 billion d) cut by $0.4 trillion e) increased by $0.4 trillion

a) increased by $250 billion

Given our class discussion, we expect that poor people have ______ MPC's than richer people. Thus, a tax cut given to poor people would have a ______ multiplier effect than one given to richer people. a) larger; larger b) smaller; larger c) larger; smaller d) smaller; smaller

a) larger; larger

Suppose the federal budget deficit for the year was $100 billion and the economy was in a recession. If the economy had been at potential GDP, it is estimated that tax revenues would have been $60 billion higher and government spending on transfer payments $50 billion lower. Using these estimates, the cyclically adjusted budget a) surplus was $10 billion b) deficit was $110 billion c) surplus was $110 billion d) deficit was $210 billion

a) surplus was $10 billion

Which of the following is true? a) the "multiplier effect" occurs when spending by the government increases the incomes of some people, which causes them to increase their spending, which increases the incomes of other people, and so on. b) the "crowding out effect" is less of a problem if actual GDP is greater than potential GDP c) the "multiplier effect" becomes larger as the marginal propensity to consume becomes smaller

a) the "multiplier effect" occurs when spending by the government increases the incomes of some people, which causes them to increase their spending, which increases the incomes of other people, and so on.

In the short run, expansionary fiscal policy ______ the price level and ______ equilibrium real GDP. a) increases; increases b) decreases; decreases c) decreases; increases d) increases; decreases

a. increases; increases

Suppose that Congress and the President are considering an increase in government expenditures of $40 billion. They consult with two economists: Alan and Robert. Alan believes that the marginal propensity to consume (MPC) is 0.9 and Robert believes that it is 0.5. If Alan is correct, then the increase in government spending will cause GDP to increase by _______, and if Robert is correct, then the government spending increase will cause GDP to increase by ______. a) $450 billion; $250 billion b) $500 billion; $100 billion c) $250 billion; $150 billion d) $150 billion; $250 billion e) $45 billion; $25 billion

b) $500 billion; $100 billion

If there are multiplier effects, then an increase in government purchases of $200 billion will shift the aggregate demand curve to the right by a) $200 billion b) more than $200 billion c) less than $200 billion d) None of the above are correct. This policy shifts the long run aggregate supply curve.

b) more than $200 billion

Government budget deficits are most likely to increase during economic ______. a) expansions b) recessions

b) recessions

During recessions, government expenditure automatically a) falls, because of the progressive income tax system b) rises, because of programs such as unemployment insurance and Medicaid c) rises, because of the progressive income tax system d) falls, because of programs such as unemployment insurance and Medicaid

b) rises, because of programs such as unemployment insurance and Medicaid

It is estimated that the tornadoes in Alabama earlier this year caused $645 million in damage in Jefferson County, Alabama alone. Suppose that Ben Gleck, a news analyst on the Coyote News Network, argues that the tornado, while tragic, will have a positive impact on the U.S. economy as it will create jobs for those involved in the clean up and reconstruction, and thus increase the amount of employment in the U.S. Mr. Gleck's argument is an example of a) the crowding out fallacy b) the broken window fallacy c) the missing variables effect d) sound economic reasoning

b) the broken window fallacy

The economy is in long-run equilibrium. Technological change shifts the long-run aggregate supply cure $120 billion to the right. At the same time, government purchases increase by $30 billion. If the MPC equals 0.8 and the crowding-out effect is $60 billion, we would expect that in the long-run, a) real GDP would be higher but the price level would be the same b) both real GDP and the price level would be lower c)real GDP would be higher but the price level would be lower d) both real GDP and the price level would be higher

c) real GDP would be higher but the price level would be lower

The economy is in long-run equilibrium. Technological change shifts the long-run aggregate supply curve $120 billion to the right. At the same time, government purchases increase by $30 billion. If the MPC equals 0.8 and the crowding-out effect is $30 billion, we would expect that in the long run, a) real GDP would be higher but the price level would be lower b) both real GDP and the price level would be lower c) real GDP would be higher but the price level would be the same d) both real GDP and the price level would be higher

c) real GDP would be higher but the price level would be the same

Suppose the federal budget deficit for the year was $100 billion and the economy was in a recession. If the economy had been at potential GDP, it is estimated that tax revenues would have been $60 billion higher and government spending on transfer payments $50 billion lower. Using these estimates, the cyclically adjusted budget a) deficit was $210 billion b) surplus was $10 billion c) deficit was $110 billion d) surplus was $110 billion

c) surplus was $10 billion

During a recession, what automatically (due to "automatic stabilizers") happens to the government's budget situation? a) tax revenues do not change; government spending falls, and the budget deficit gets smaller. b) tax revenues fall, government spending falls, and the effect on budget deficit is ambiguous. c) tax revenues fall, government spending increases, and the budget deficit gets larger. d) tax revenues rise; government spending increases, and the effect on budget deficits is ambiguous.

c) tax revenues fall, government spending increases, and the budget deficit is ambiguous.

An increase in government spending causes money demand to _____, which causes interest rates to ______, which causes investment spending to _____. This is known as "crowding out." a) decrease; decrease; increase b) decrease; decrease; decrease c) increase; increase; increase d) increase; increase; decrease e) none of the above

d) increase; increase; decrease

If the MPC is 0.8, real GDP is $15 trillion, and potential real GDP is $13 trillion, then taxes would need to be _____ to restore the economy to potential real GDP. a) cut by $2 trillion b) cut by $1.6 trillion c) cut by $0.5 trillion d) increased by $0.5 trillion 3) increased by $2 trillion

d) increased by $0.5 trillion

Crowding out will be greater a) the less sensitive consumption spending is to changes in the interest rate b) the further equilibrium GDP is below potential GDP c) if the economy is in recession, rather than at full employment d) the more sensitive investment spending is to changes in the interest rate

d) the more sensitive investment spending is to changes in the interest rate

to calculate marginal propensity to consume:

divide consumption by disposable income