C719 - MACRO UNIT 4 / Module 8 Quizzes

Module 8 Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to 0.75, there would be a ----------- in taxes needed to close the recessionary gap and restore full employment.

$100 decrease (The tax change multiplier is equal to -3 when the MPC is 0.75, so a $100 decrease in taxes causes a $300 increase in equilibrium income.)

Module 8 For a scenario similar to that in Figure 8.2 (all values are in billions of dollars), assume that the current equilibrium income is $3,300, but the target level of income is $3,500. If the initial increase in government purchases (G) of $50 achieves the target income level, then the recessionary gap is __________.

$200 and the expenditure multiplier is 4 The recessionary gap is ($3,500 - $3,300) = $200. Since $200/$50 is equal to 4, the expenditure multiplier is equal to 4.

Module 8 The best example of an expansionary fiscal policy, designed to increase aggregate spending, is __________.

increased public spending on infrastructure and a reduction in the income tax

Module 8 The goal of fiscal policy is to __________.

influence employment, inflation, and economic growth

If the impact of expansionary fiscal policy is delayed until the economy has already recovered by itself, it is possible that policy intended to combat __________.

recession may simply fuel inflation

The length of time needed to become aware of an economic problem is called the ------------- lag. The time it takes after a problem is recognized to choose and enact a fiscal policy in response is the ------------ lag. The ----------- lag is the time that elapses between the implementation of a fiscal policy and its full effect on economic activity.

recognition ; implementation ; impact

Fiscal policy is most effective when policy lags are

short

Module 8 A discretionary fiscal policy of tax credits to electric car manufacturers in order to reduce costs of setting up a new factory is primarily a __________.

supply side effect

Fiscal policy is most effective when policymakers are motivated to pursue actions __________.

that improve the economy's performance

Module 8 Automatic stabilizers are __________.

put into place and left to respond automatically to changes in the level of economic activity

Module 8 Using Figure 8.2, assume equilibrium income is currently $3,000, but the target level of income, which is consistent with full employment, is $3,500. If the expenditure multiplier is 10, then the increase in government spending needed to reach the target level of income will shift the aggregate expenditure function upward by ---------, causing equilibrium income to increase by ----------.

$50 ; $500

Module 8 Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to 0.75, there would be a ----------- increase in government spending needed to close the recessionary gap and restore full employment.

$75 increase The government expenditure multiplier is equal to 4 when the MPC is 0.75, so a $75 increase in government spending causes a ($75) × (4) = $300 increase in equilibrium income.

Module 8 Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to 0.75, the value of the tax change multiplier is ---------.

-3 The tax change multiplier is [-MPC/(1 - MPC)], which is -0.75/0.25 or -3 if the MPC is 0.75

Module 8 This shows that the current value of the MPC, or marginal propensity to consume, is equal to ----------.

.9 Since the multiplier is equal to 1/(1 - MPC), the MPC must be 0.9 to get the result 1/(1 - 0.9) equal to 10.

Module 8 Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to 0.75, the value of the government expenditure multiplier is ---------.

4 The government spending multiplier is [1/(1 - MPC)], which is 1/0.25 or 4 if the MPC is 0.75.

Module 8 Suppose equilibrium income is currently $4,200, but the target level of income in which the economy achieves full employment is $4,500. If the MPC is equal to 0.75, what change in government spending and taxes can close the recessionary gap and restore full employment, while maintaining a balanced budget?

A $300 increase in both government spending and taxes can close the recessionary gap.

Module 8 ---------- partially offset changes in private spending, tend to reduce fluctuations in output and employment, and are triggered by changes in the economy. Therefore, they ---------- require further action by Congress.

Automatic Stabilizers ; do not

True or False. Because economic conditions can influence political outcomes, economists are certain that politicians are able to create a political business cycle for their own benefit.

FALSE

Module 8 ------------ economists argue that it is difficult, if not impossible, for the government to determine exactly the amount of fiscal policy necessary to reach the full-employment levels. ------------ economists believe that active fiscal policy is a valuable tool for stabilizing economic activity.

Classical ; Keynesian

True or False. Discretionary fiscal policy makes an economy more stable when there are lengthy policy lags.

FALSE

Module 8 True or False. When the economy is doing well and income and output are rising at a healthy rate, transfer payments for food stamps, unemployment compensation, and social security are likely to rise.

FALSE (Fewer people will be eligible for these programs when the economy is healthy, so these payments are likely to fall.)

Module 8 True or False. An equal increase in government spending and taxes will have no effect on equilibrium income.

FALSE (For example, if government spending and taxes are both increased by $20 billion, equilibrium income will increase by $20 billion.)

Module 8 True or False. Keynesian economists advocate using fiscal policy to offset any shift in aggregate demand that will cause equilibrium income to deviate from full-employment income.

FALSE (Keynesian economists advocate using policy to offset shifts that have substantial and prolonged effects on output, employment, and prices.)

Module 8 True or False. If the economy achieves full employment at an income level of $15 trillion, and equilibrium income is currently $14.9 trillion, Keynesian economists recommend using fiscal policy to reduce equilibrium income.

FALSE (Keynesians would probably not recommend using fiscal policy here because the difference between full employment at $15 trillion and the current employment at $14.9 trillion is relatively minor and probably not considered a substantial or prolonged difference. If at all fiscal policy is recommended, it would be used to increase income to reach the target level income.)

Module 8 True or False. To stabilize the economy, fiscal policy should be used to reduce spending during recessions and increase spending during inflationary periods.

FALSE (Stabilizing the economy means using expansionary policy when spending is too low and using contractionary policy when spending is too strong.)

True or False. If consumers react to a temporary increase in disposable income by saving most of it instead of spending it, then the policy has had more of an effect on output than if the consumers spent all of it.

FALSE (The size of the multiplier effect depends on the amount of new spending caused by policy. Failure to respond means consumers are not spending in response to the policy, so it will have little or no effect.)

Module 8 The Keynesian consumption function was first modified by------------ to account for differences in spending patterns that occur over the life cycle. These ideas were further developed by ------------, who hypothesized that current consumption depends on past income and expected future income and not current income alone.

Franco Modigliani ; Milton Friedman

The 1964 and 1981 income tax cuts, which were enacted as permanent changes, appear to have had more effect on income and consumption than the 1968 temporary surcharge or the 1975 one-time tax rebate. What is the most probable explanation for this?

Permanent tax cuts increase permanent income, which in turn increases current consumption.

Module 8 Which proposed tax cut is likely to have the largest effect on output, according to the permanent income hypothesis?

Permanently reducing tax rates at all income levels by 10% (A permanent change in tax rates creates an increase in currency and expected future disposable income.)

Module 8 Based on the chart below, what is the income tax? Family............Taxable Income............Tax Payment Due Lopez............$50,000............................$6,000 Gonzales.....$100,000..........................$10,000 Martinez......$200,000..........................$16,000

Regressive (The tax payment decreases from 12% for the Lopez family, to 10% for the Gonzales family, and 8% for the Martinez family.)

Module 8 Which category of transfer programs is least likely to change in response to changing economic conditions?

Social Security survivor's benefits (A family is eligible for a survivor's benefits when a covered employee (parent or spouse) dies; this is not an event that depends on the state of the economy.0

Module 8 True or False. According to Keynesian theory, fiscal policy works by shifting the aggregate demand curve to either increase output and employment or reduce the price level.

TRUE

Module 8 True or False. According to the Keynesian model, the economy varies from the goal of full employment when aggregate expenditure is too low.

TRUE

Module 8 True or False. According to the Keynesian model, there is sometimes a conflict between actions that are in the social interest and actions that are in a person's self-interest.

TRUE

Module 8 True or False. Congressional legislation over the years, much of it enacted during the Great Depression, has created a system of tax collections and transfer payments that change automatically in response to changes in national income.

TRUE

Module 8 True or False. The Bush and Clinton tax increases in 1990 and 1993 were both intended primarily to control the deficit rather than to influence the level of output.

TRUE

True or False. According to Friedman's permanent income hypothesis, a 22-year-old who is in college with no children and no scholarship will likely spend more preparing for his future than a 22-year-old with no children and with very little education or job experience.

TRUE

True or False. The three fiscal policy lags are the recognition lag, the implementation lag, and the impact lag.

TRUE

Which statement about the U.S. political system is false?

U.S. Senators are all elected every four years. (Senators serve six-year terms and one-third of the Senate is up for election every two years.)

According to Franco Modigliani, which groups are most likely to engage in dissaving?

Young families and retired individuals

Fiscal policy is most effective when __________.

a tax cut has a large effect on consumer spending

Based on the Keynesian model, policymakers are able to use ---------- fiscal policy to reduce inflation and ---------- fiscal policy to reduce unemployment. Used correctly, active fiscal policy should ---------- the ups and downs of the business cycle.

contractionary expansionary decrease

Module 8 The best example of a contractionary fiscal policy, designed to decrease aggregate spending, is __________.

decreased spending on national defense and elimination of tax loopholes

According to the political business cycle theory, when inflation is not a problem, a politician seeking reelection is likely to pursue __________.

expansionary fiscal policy prior to the election, so voters will be satisfied with the state of the economy

Module 8 When the economy is booming, income is rising __________.

faster than normal, so tax revenues are likely to be higher than anticipated

According to economist Douglas A. Hibbs Jr., economic conditions at the time of an election __________.

have a definite effect on the success or failure of the incumbent party

If a politician is seeking to reduce unemployment and increase economic growth prior to an election, the fiscal policies that would most likely achieve these goals would be to -------- government spending and -------- taxes.

increase ; decrease

Module 8 Because of the multiplier process, if a tax cut causes consumption spending to initially rise by $100, the resulting change in income is likely to be __________.

larger than $100, as spending by one person creates additional income for another person

Module 8 Based on the information presented in the following table, the income tax is __________. Family...........Taxable Income...........Tax Payment Due Lopez..........$50,000............................$4,000 Gonzales...$100,000...........................$10,000 Martinez....$200,000..........................$24,000

progressive (The tax payment increases from 8% for the Lopez family, to 10% for the Gonzales family, and 12% for the Martinez family.)

Module 8 Based on the information presented in the following table, the income tax is __________. Family..........Taxable Income............Tax Payment Due Lopez..........$50,000............................$5,000 Gonzales....$100,000..........................$10,000 Martinez.....$200,000.........................$20,000

proportional (The tax payment is the same percentage of taxable income (10%) for all three families, so the tax is proportional.)