Principles of Economics Section 9: Fiscal Policy

A decrease in government spending is ________ fiscal policy.

contractionary

changes in the money supply

is NOT a method of fiscal policy

An increase in transfers is expansionary _________ policy.

fiscal

True or False? Government spending to pay salaries to soldiers is a transfer payment.

False A transfer payment is a government payment to households for which no good or service is received in return.

Suppose the government begins the year with $6 trillion of public debt. During the year, it collects taxes of $4 trillion and spends $7 trillion on transfers and government purchases of goods and services. The public debt at the end of the year is:

$9 trillion. The deficit for the year is $3 trillion and that makes the public debt grow to $9 trillion.

The multiplier is:

1/(1-MPC)

Suppose that the economy is at equilibrium at $1,600 billion, and potential output is $1,200 billion. If the MPC is 0.75, government spending must decrease by ______ billion dollars to reach potential output.

100 If the MPC is 0.75, the multiplier is 4, so government spending must decrease by $100 billion to close the $400 billion gap.

If the MPC is 0.8 and government spending decreases by $1 trillion, real GDP will decrease by _____ trillion dollars from the initial effect of the decrease in government spending and a further ______ trillion dollars from the decrease in consumption.

1; 4 The initial effect of the decrease in government spending leads to a decline in consumption.

If the MPC = 0.6, then the government spending multiplier is:

2.5. The multiplier is calculated as 1/(1 - MPC) = 1/(1 - 0.6) = 1/0.4 = 2.5.

Suppose that the economy is at equilibrium at $1,000 billion, and potential output is $1,200 billion. If the MPC is 0.9, government spending must increase by ______ billion dollars to reach potential output.

20 If the MPC is 0.9, the multiplier is 10, so government spending must increase by $20 billion to close the $200 billion gap.

Suppose that the economy is at equilibrium at $1,500 billion, and potential output is $1,200 billion. If the MPC is 0.9, government spending must decrease by ______ billion dollars to reach potential output.

30 If the MPC is 0.9, the multiplier is 10, so government spending must decrease by $30 billion to close the $300 billion gap.

If the marginal propensity to consume is 0.75, the government spending multiplier is:

4. The government spending multiplier is 1 divided by 1 minus the marginal propensity to consume, 1/(1/0.75) = 4.

Suppose that the economy is at equilibrium at $1,000 billion, and potential output is $1,200 billion. If the MPC is 0.75, government spending must increase by ______ billion dollars to reach potential output.

50 If the MPC is 0.75, the multiplier is 4, so government spending must increase by $50 billion to close the $200 billion gap.

Suppose that the government overestimates the amount of government spending needed to close a recessionary gap. Which of these scenarios is likely to happen?

An inflationary gap occurs.

Assume that marginal propensity to consume is 0.8 and potential output is $800 billion. If the actual real GDP is $850 billion, which policy would bring the economy to potential output?

Increase taxes by $12.5 billion.

Suppose that the marginal propensity to consume is 0.75. If government spending for goods and services increases by $30 billion, what will be the total effect on real GDP?

It will increase by $120 billion.

Suppose that the budget deficit of a country remains level for five years. Which is true concerning the fiscal stance of this government?

The federal debt will rise.

During a recession, the budget tends to move toward:

a deficit.

temporary tax cuts enacted by Congress to fight a recession are considered to be:

a discretionary fiscal policy intended to be expansionary.

Government tax revenue rises and falls with the business cycle as:

an automatic stabilizer.

a progressive income tax is an example of an

automatic stabilizer.

The initial effect of the decrease in government spending leads to a ________ in consumption.

decline

Expansionary fiscal policy will:

decrease the size of a budget surplus.

If tax revenues are $2 trillion, transfers are $0.5 trillion, and government spending on goods and services is $3 trillion, the budget balance is a _______ of _______trillion dollars.

deficit; 1.5 The budget balance is tax revenue ($2 trillion) minus transfers ($05. trillion) minus government spending on goods and services ($3 trillion), which is $1.5 trillion, which is a deficit.

A decrease in __________ is contractionary fiscal policy.

government spending

If government transfer payments rise by $100 billion, and this increases real GDP by $120 billion, then we can conclude that the multiplier for government transfers is:

greater than one.

Spending promises made by governments that are effectively a debt, despite the fact that they are not included in the usual debt statistics, are known as:

implicit liabilities

If the MPC is 0.8 and taxes decrease by $200, real GDP will

increase by $800. Real GDP will increase by the increase in consumption $160 (0.8 times the tax decrease of $200 = $160) times the multiplier of 5, which is an increase of $800.

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

increase by less than $120 billion.

Contractionary fiscal policy will _______ the size of a budget surplus or _______ the size of a budget deficit.

increase; decrease Contractionary fiscal policy, which involves increasing taxes, decreasing transfers, and decreasing government spending on goods and services will make a surplus larger or make a deficit smaller.

Which fiscal policy would make a budget surplus larger or a budget deficit smaller?

lower government transfers

Because of the ________, an increase in government spending results in a larger increase in real GDP.

multiplier Because the multiplier effect of a change in spending on incomes and on further spending, an increase in government spending causes an increase in GDP that is larger than the initial increase in government spendin

Which represents the largest source of tax revenue for the U.S. federal government?

personal income taxes

If the economy is at equilibrium below potential output, there is a(n):

recessionary gap, and expansionary fiscal policy is appropriate.

To close an inflationary gap by employing fiscal policy, the government could:

reduce budget allocations to interstate highway maintenance.

All else equal, when the unemployment rate decreases, the budget:

surplus gets larger or the budget deficit gets smaller.

The multiplier is the ratio of:

the change in real GDP to the change in autonomous spending.

Suppose the economy is operating at an output level of $5400 billion. Assume furthermore that potential output is $5000. Which would be necessary to close this inflationary gap if the marginal propensity to consume is 0.75?

Decrease spending by $100 billion.

True or False? A decrease in government transfers is expansionary fiscal policy.

False

True or False? As the size of the debt grows, the amount of interest payments that the government must pay decreases.

False

True or False? One of the lags in fiscal policy is a consequence of the time it takes to develop a spending plan to combat a recession.

True

True or False? The federal government spends more on health care than on education and defense.

True

True or False? The time it takes to collect and analyze macroeconomic data is a cause of lags in fiscal policy.

True

True or False? A negative budget balance is a deficit.

True A deficit is a negative budget balance that occurs when transfers and government spending on goods and services are greater than tax revenues.

True or False? An increase in taxes will reduce the budget deficit.

True A tax increase is contractionary policy that will reduce a deficit or increase a budget surplus.

lowering payroll tax rates during a recession

is an example of discretionary fiscal policy.