CHAPTER 11 QUIZ
The effectiveness of an expansionary fiscal policy will be reduced if: A) borrowing increases interest rates and crowds out private investment B) accompanied by a cut in Social Security taxes as well C) the price level falls D) stock prices rise
A This so-called "crowding-out effect" will lead to a lower than expected increase in aggregate demand, as decreases in private investment partially offset increases in other expenditures. However, the likelihood of this effect may be small.
Built-in stabilizers: A) automatically increase the size of deficits when the economy experiences demand-pull inflation B) avoid the problems associated with the administrative lag of discretionary fiscal policy C) automatically produce a cyclically balanced budget D) tend to offset the impact of discretionary fiscal policy
B Built-in stabilizers automatically move the government's budget toward surplus during expansions and toward deficit during recessions without requiring explicit government action. Thus, there is no lag between the recognition of a problem and Congress taking appropriate action.
In 2002, the Federal government spent $2472 billion while its revenues were $2154 billion. The $318 billion difference is the: A) full-employment budget B) deficit C) surplus D) public debt
B The deficit is the amount by which spending exceeds revenue in a given year.
In 2005, the debt held by the public as a percentage of GDP was about: A) 17% B) 69% C) 31% D) 116%
C In 2005, GDP was about $12,500 billion and the public debt was about $3,860 billion.
Refer to the diagram. A contractionary fiscal policy is best represented by graph: A) A B) B C) C D) D
D A contractionary fiscal policy (raising taxes or cutting government spending) will push the aggregate demand curve to the left: expenditures decrease for any given price level.
Approximately what proportion of the U.S. public debt is "owed to ourselves," either as securities held by the U.S. public or by U.S. governments? A) less than 25% B) 25% to 50% C) 50% to 70% D) more than 70%
D As of 2005, about 26% of the public debt was held by foreign individuals and institutions.
Refer to the table. The changes in the budget conditions between 2005 and 2006 best reflect: A) demand-pull inflation B) a cut in government spending C) a tax increase D) an expansionary fiscal policy
D Both the actual and standardized budget deficits increased, suggesting that either government spending increased, taxes were cut, or both in an attempt to stimulate the economy.
A contractionary fiscal policy generally results in a lower price level. A) True B) False
FALSE Contractionary fiscal policy is often intended to slow down an increase in the price level. In general, the aggregate price level is "sticky" in the downward direction.
Built-in stabilizers arise from the fact that tax revenues vary directly with GDP. A) True B) False
TRUE The economy's built-in stabilizers operate by automatically causing the government's budget to move toward deficit during a recession and toward surplus during an expansion. Although government purchases do not automatically adjust, tax revenue does because of the direct relationship between GDP and the income that is subject to taxes.
Which of the following discretionary policies both restrains the growth of government and stabilizes the economy at full-employment? A) A tax cut in a recession B) A tax increase during inflation C) An increase in government spending during a recession D) A decrease in government spending in a recession
A A decrease in government spending in a recession would decrease the size of government, but it would also be counterproductive. Tax cuts in a recession would expand GDP while also restraining the size of government.
Refer to the diagram. If the full-employment level of GDP is $500 billion: A) the government is running a standardized budget surplus B) the government is running a standardized budget deficit C) the government's fiscal policy is expansionary D) the economy is in a recession
A If the economy were to produce the full-employment level of GDP with the current tax and spending structure, tax revenue would exceed spending by $50 billion.
An economy currently is experiencing a negative GDP gap of $500 billion, or 3% of its GDP. An appropriate fiscal policy would be: A) a decrease in taxes B) a decrease in government spending C) an equal decrease in taxes and government spending D) an increase in interest rates
A The economy is experiencing a recession, so an expansionary fiscal policy is appropriate. This can be accomplished by cutting taxes or increasing government spending. Because tax changes have a smaller dollar-for-dollar impact, a balanced increase in both taxes and government spending would also be expansionary.
Suppose the full-employment level of GDP is $250 billion. Currently, aggregate expenditures total $220 billion. Which of the following would be most in accord with appropriate fiscal policy? A) Reduce tax rates on personal income B) Reduce government expenditures C) Raise the tax on corporate income to discourage investment D) Raise the interest rate on government bonds to encourage saving
A The economy is suffering from a negative GDP gap and an expansionary fiscal policy would be appropriate. This would entail lowering taxes, increasing government spending, or both.
Compared to a proportional tax, a progressive tax system: A) increases built-in stability B) reduces built-in stability C) increases the size of the standardized budget deficit D) shifts the aggregate supply curve to the right
A With a progressive tax system, tax revenues fall by a greater amount during a recession and increase by a greater amount during an expansion, dampening the swings in the business cycle.
Congressional changes in taxes and spending intended to stabilize the economy: A) are mandated by the Federal Reserve Act of 1913 B) is referred to as discretionary fiscal policy C) offsets the economy's built-in stabilizers D) are designed to expand GDP in times of demand-pull inflation
B Discretionary fiscal policy refers to changes in taxes and spending made by Congress to stabilize the economy and is mandated by the Employment Act of 1946.
Of the following fiscal policies, which one is most expansionary? A) $100 billion tax cut B) $100 billion increase in government spending C) $100 billion increase in both government spending and taxes D) $100 billion decrease in both government spending and taxes
B Government spending increases aggregate demand directly; part of any tax cut is drained into saving.
Refer to the graph. Suppose the full-employment level of GDP is Q1, but a significant decline in investment demand has pushed the economy into recession as shown by the decline in aggregate demand to AD2. Currently, output is at Q3 and there is a negative GDP gap of $100 billion. If the multiplier is 5, which of the following would most likely move the economy back to its full potential? A) A tax cut of $20 billion B) Increased government spending of $20 billion C) A tax cut of $100 billion D) Increased government spending of $100 billion
B If the multiplier is 5, a $20 billion increase in government spending will shift aggregate demand from AD2 back to AD1 and restore GDP to its full-employment level. A tax cut of more than $20 would be required to accomplish the goal, as part of a tax cut would be saved rather than added as new spending.
Of the following groups, the largest proportion of the public debt is held by: A) foreign individuals and institutions B) U.S. government agencies, including the Federal Reserve C) State and local governments D) U.S. individuals, banks, and other financial institutions
B Of these four distinct groups, the amount held by the Federal government (including the Fed) is the largest (about one-third of the total), although the combined amounts held by the public (U.S. individuals, banks, other financial institutions, and state and local governments) exceeds that held by the government.
A very high level of U.S. public debt to GDP: A) may bankrupt the U.S. B) cannot bankrupt the U.S. because of its ability to tax and to refinance its debt C) is, by itself, evidence of the burden of the debt on future generations D) will offset any attempts at expansionary fiscal policy
B The U.S. cannot "go bankrupt" because it has the authority to tax to repay the debt and because it can pay off existing bond holders by issuing new debt.
Which of the following exemplifies the crowding-out effect? An increase in government spending: A) is financed by increasing the money supply, reducing interest rates and causing net exports to fall B) is financed by borrowing, raising interest rates and causing private investment to fall C) causes taxes to rise automatically, reducing consumption spending D) causes the price level to rise, reducing net exports
B The crowding-out effect refers to the decrease in private investment spending which may accompany an expansionary fiscal policy financed by government borrowing from the public. An expansionary fiscal policy may generate increased spending by government and consumers but reduced spending by investors.
Suppose the full-employment level of GDP is $250 billion in a hypothetical economy. Currently, aggregate expenditures total $270 billion. Which of the following would be most in accord with appropriate fiscal policy? A) Lower tax rates on corporate income B) Lower personal exemption amounts for each dependent when figuring personal income taxes C) Expanded spending on new domestic security programs D) Decreases in interest rates
B This economy has a positive GDP gap and is likely experiencing demand-pull inflation. A contractionary fiscal policy would be appropriate, and would entail either higher taxes or reduced government spending. Reducing the size of personal exemptions would increase the amount households pay in taxes.
An increase in the tax rate, all else equal, will: A) reduce the size of cyclical deficits B) increase the regressivity of the tax system C) increase the built-in stability of the economy D) reduce the built-in stability of the economy
C A higher tax rate reduces the size of the multiplier by reducing the after-tax MPC, thereby reducing the overall impact of changes in investment, consumption, or net exports. Further, the higher tax rate automatically generates greater tax relief during economic downturns and greater surpluses when there is a positive GDP gap.
An expansionary fiscal policy is best represented by graph: A) A B) B C) C D) D
C An expansionary fiscal policy (cutting taxes or increasing government spending) will push the aggregate demand curve to the right: expenditures increase for any given price level.
An expansionary fiscal policy would call for a: A) deficit during a period of demand-pull inflation B) surplus during a period of demand-pull inflation C) deficit during a recession D) surplus during a recession
C An expansionary fiscal policy is designed to expand real GDP, as would be appropriate in a recession. This is accomplished by increasing spending, either directly through government spending or indirectly through a tax cut.
Refer to the diagram. If the full-employment level of GDP is $400 billion but the actual level of GDP is $300 billion: A) the actual budget and standardized budget are both balanced B) the actual budget is in surplus while the standardized budget is balanced C) the actual budget is in deficit while the standardized budget is balanced D) the actual budget is balanced while the standardized budget is in surplus
C At the full-employment level of $400 billion, tax revenue and government spending are equal; at the current level of $300 billion, government spending exceeds tax revenue by $50 billion.
Refer to the graph. If AD1 represents the current level of expenditures and Q2 is the full-employment level of GDP the economy is: A) in a recession and expansionary fiscal policy is in order B) in a recession and contractionary fiscal policy is in order C) experiencing demand-pull inflation and expansionary fiscal policy is in order D) experiencing demand-pull inflation and contractionary fiscal policy is in order
C If aggregate demand is given by AD1 and Q2 is the full-employment level of GDP, then the current equilibrium real GDP level of Q1 is beyond the economy's capacity to produce and will result in demand-pull inflation. The appropriate fiscal stance is contractionary.
If the MPC is .6, a $100 billion lump-sum tax cut would shift the aggregate demand curve to the right by: A) $25 billion B) $60 billion C) $150 billion D) $250 billion
C The tax cut would increase disposable income by $100 billion, of which $40 billion would be saved and $60 billion would be spent. The multiplier is 2.5, so the aggregate demand curve shifts to the right by 2.5 times $60 billion, or $150 billion.
A strict rule requiring a constantly balanced actual budget would: A) increase the effectiveness of built-in stabilizers B) be impossible with a progressive tax system C) produce a standardized budget surplus when the economy is producing beyond its potential GDP D) produce a standardized budget surplus when the economy is in a recession
D If the economy were in a recession, tax revenues would automatically fall. This rule would require either that taxes be increased or that government spending be cut, either of which would generate a balanced-budget surplus and further destabilize the economy.
The majority of the public debt does not represent a burden on future generations because: A) future generations need pay back only the interest on borrowed funds, not the principal B) the debt can be paid off by selling government land, buildings, and other real assets C) the debt can be paid off by printing new money D) the majority of the debt is owned by the U.S. public and institutions
D In addition to inheriting the obligation to pay back the debt, future generations also inherit (most of) the ownership of the debt through their holdings of Treasury securities and savings bonds.
Suppose the government's actual budget is in balance but its standardized budget shows a surplus. It can be concluded that: A) the government's fiscal policy is expansionary B) the economy is actually operating at full employment C) the economy is experiencing demand-pull inflation D) The economy is currently operating below its potential
D The standardized budget indicates the relationship between government taxes and revenues at the full-employment level of GDP. In this example, the standardized budget is in surplus. Since tax revenues are directly related to GDP, the actual budget could be in balance only if GDP is below the full employment level.
