Econ 1a Ch.14

If the mpe is equal to 0.90 and equilibrium income is $300 billion more than potential income, the Multiplier Model predicts that potential income can be attained by ______________ government spending ___________________. A. decreasing; by $30 billion B. decreasing; by $60 billion C. decreasing; by $90 billion D. decreasing; by $300 billion

A Given that the multiplier is (1/1-.9) = 10, if there is an inflationary gap equal to $300 billion, the government needs to decrease government spending by $300/10 = $30 billion. $30 billion x 10 = $300 billion.

According to Keynes, if aggregate demand is too high and an inflationary gap is beginning to develop in the economy, fiscal policy should be contractionary. True False

True. A contractionary fiscal policy prescription or raising taxes and/or decreasing government spending will help to reduce aggregate demand and thus reduce the inflationary gap.

Financing expansionary fiscal policy through the sale of additional government bonds (and thus increasing the deficit) may have offsetting effects on the economy that may dampen the overall stimulative effect on aggregate demand (and thus equilibrium real income in the economy) from that policy prescription. True False

True. Financing a deficit typically does put upward pressure on interest rates because the government must issue additional bonds to finance the deficit. As such, higher interest rates will have an offsetting effect, thereby dampening the increase in equilibrium real income from the expansionary fiscal policy prescription. This is formally referred to as "Crowding Out."

The elimination of automatic stabilizers would most likely increase the need for more fiscal policy prescriptions. True False

True. Without automatice stabilizers, equilibrium income in the economy would be subject to greater swings, thus increasing the need for more fiscal policy action by the government to help minimize the magnitude of the business cycle, and thus the swings in equilibrium income.

Based upon what we have learned in this chapter, the best way to help reduce/eliminate an inflationary gap and decrease the economy's equilibrium income down to its potential income level is to: A. decrease aggregate expenditures by a government spending increase or tax decrease. B. decrease aggregate expenditures by a government spending decrease or tax increase. C. increase aggregate expenditures by a government spending increase or tax decrease. D. increase aggregate expenditures by a government spending decrease or a tax increase.

B Decreasing aggregate demand by decreasing government spending or increasing taxes is a way the government can decrease equilibrium income and fight the inflationary gap.

Suppose the U.S. economy is in a recession, and the recessionary gap is equal to $250. If the mpe is 0.80, how much should the government spend to eliminate the recessionary gap? A. Increase spending by $250. B. Increase spending by $125. C. Increase spending by $50. D. Increase spending by $25.

C In order for the government to eliminate the recessionary gap, they would have to spend a fraction of the actual gap. In this case, to find that amount, all we have to do is take the amount of the gap and divide it by the multiplier, which in this case is (1/1-.8) = 5. Therefore, $250/5 = $50.

If the economy is in a recession, one fiscal policy that might help the economy recover is: A. a reduction in social security payments. B. an increase in the income tax rate. C. an increase in defense spending. D. a reduction in unemployment compensation.

C Increasing government spending on defense is the only example of expansionary fiscal policy out of the four possible solutions given in this question, and therefore is the only solution that will help the economy recover from its recession.

Which of the following is an example of a countercyclical fiscal policy? A. An increase in government spending when the economy is in a boom phase. B. A reduction of the tax rate when the economy is in a boom phase. C. A decrease in government spending when the economy is in a recession. D. An increase in the tax rate when the economy is in a boom phase.

D An increase in the tax rate when the economy is in a boom phase is the only example of the four potential solutions that is an example of a countercyclical fiscal policy.

The purpose of an expansionary fiscal policy is to: A. To reduce both aggregate demand and inflationary pressure. B. reduce interest rates. C. reduce aggregate demand, employment, and output. D. increase aggregate demand, employment, and output.

D Expansionary fiscal policy is designed to increase equilibrium income by increasing aggregate expenditures, thus aggregate demand, employment, and output. Lowering interest rates is done either through contractionary fiscal policy and thus running surpluses, or more typically through monetary policy.

Fiscal policy influences the economy through changes in: A. the money supply, credit availability, and interest rates. B. regulatory controls. C. antitrust enforcement. D. taxes, transfers, and expenditures.

D Fiscal policy includes any policy that influences or changes taxes, transfer payments (Unemployment insurance, etc.), and expenditures. In other words, changing government outlays and/or tax receipts. Changing the money supply is a function of the Federal Reserve and Monetary Policy, not Congress and Fiscal policy per se.