module 20-21

Expansionary fiscal policy causes the aggregate demand curve to shift to the _______ and is used to close a(n) _______ gap.

right; recessionary

The basic equation of national income accounting shows: GDP = C + I + G + X - IM. When the government uses fiscal policy to make changes to taxes and transfers, this policy primarily affects:

C

Assume that marginal propensity to consume is 0.8, and potential output is $800 billion. If current real GDP is $700 billion, which of the following policies would bring the economy to potential output?

Decrease taxes by $25 billion.

If the government decides to spend an extra $5 billion:

GDP will increase by more than $5 billion.

When the economy expands, which of the following is true?

Income tax receipts and sales tax revenues will both rise.

Assume that marginal propensity to consume is 0.8, and potential output is $800 billion. If current real GDP is $700 billion, which of the following policies would bring the economy to potential output?

Increase government spending by $20 billion.

Figure 20-3: North Placid Government nar001-1.jpg Use the "North Placid Government" Figure 20-3. Using the accompanying figure, which of the following would be the appropriate response on the part of the North Placid government?

Increase taxes to close the inflationary gap.

The multiplier effect of changes in government transfers is equal to:

MPC/(1 - MPC).

Assume that the MPC = 0.8 and the government increases spending by $100 billion, financing this spending with a $100 billion tax increase. Which of the following will be the likely effect of this action?

Real GDP will expand by $100 billion.

Suppose the government increases spending more than is necessary to close a recessionary gap. Which of the following is likely to be the end result?

The economy will experience inflation.

Figure 20-4: Inflationary and Recessionary Gaps nar002-1.jpg Use the "Inflationary and Recessionary Gaps" Figure 20-4. An inflationary gap would be:

Y3-Y2.

Figure 20-8: Fiscal Policy Options nar006-1.jpg Use the "Fiscal Policy Options" Figure 20-8. If the aggregate demand curve is AD":

a contractionary fiscal policy may be warranted.

Figure 20-9: AD-AS nar007-1.jpg Use the "AD-AS" Figure 20-9. Suppose the economy is producing the output level Yp, and a negative demand shock shifts the AD1 curve to AD3. The economy now has

a recessionary gap and expansionary fiscal policy can close the gap.

Suppose the economy is experiencing a recessionary gap. To move equilibrium aggregate output closer to the level of potential output, the best fiscal policy option is to:

decrease taxes.

A reduction in government transfers ________, therefore shifting the aggregate demand curve to the ________.

decreases disposable income and consumption; left

Expansionary fiscal policy includes:

decreasing taxes.

Changing the level of government spending is an example of

fiscal policy.

John Maynard Keynes believed that the:

government should actively try to mitigate the effects of recessions by using fiscal and monetary policies.

Contractionary fiscal policy would include:

increased taxes.

Expansionary fiscal policy:

increases aggregate demand.

Expansionary fiscal policy includes:

increasing government expenditures.

Contractionary fiscal policy includes:

increasing taxes.

One of the shortcomings of fiscal policy is that:

it has time lags and sometimes it may end up destabilizing the economy as a result of these lags.

When the economy is in a recession:

tax receipts decrease but unemployment insurance payments increase.

Fiscal policy attempts to affect the level of overall spending in the economy by changes in:

taxes and spending.

Medicaid, Medicare and Social Security are examples of:

transfer payments.

A contractionary fiscal policy:

typically decreases a government budget deficit or increases a government budget surplus.

If the marginal propensity to consume is .80, and the federal government decreases spending by $200 billion, the income expenditure model would predict that real GDP will decrease by:

$1000 billion.

If the MPC is 0.8 and the government spending decreases by $50 million, then equilibrium GDP will decrease by:

$250 million.

If the marginal propensity to consume is .9, then the government spending multiplier has a value of

10

If the MPC is 0.9, then the government spending multiplier is:

10.

Suppose the economy is currently operating at an output level of $4,000 billion. Assume furthermore that potential output is $5,000 billion and the marginal propensity to consume is 0.75. Which of the following would be required to close this recessionary gap?

A $250 billion increase in government spending.

Figure 20-6: Fiscal Policy II nar004-1.jpg Use the "Fiscal Policy II" Figure 20-6. Suppose that this economy is in equilibrium at E1. If there is an increase in taxes, then:

AD1 will shift to the left, causing a decrease in the price level and a decrease in the real GDP.

Figure 20-5: Fiscal Policy I nar003-1.jpg Use the "Fiscal Policy I" Figure 20-5. Suppose that this economy is in equilibrium at E1. If there is a decrease in taxes, then:

AD1 will shift to the right, causing an increase in the price level and an increase in real GDP

Congress increases the personal income tax in order to balance the budget. Which of the following is likely to result?

Automatic stabilizers will decrease the contractionary impact of the decrease in aggregate demand.

Figure 20-6: Fiscal Policy II nar004-1.jpg Use the "Fiscal Policy II" Figure 20-6. Suppose that this economy is in equilibrium at E1. If there is a decrease in taxes, then:

AD1 will shift to the right, causing an increase in the price level and an increase in real GDP.

Figure 20-6: Fiscal Policy II nar004-1.jpg Use the "Fiscal Policy II" Figure 20-6. Suppose that this economy is in equilibrium at E2. If there is a decrease in government transfers, then:

AD2 will shift to the left, causing a decrease in the price level and a decrease in the real GDP.

Figure 20-6: Fiscal Policy II nar004-1.jpg Use the "Fiscal Policy II" Figure 20-6. Suppose that this economy is in equilibrium at E2. If there is an increase in government transfers, then:

AD2 will shift to the right, causing an increase in the price level and an increase in real GDP.

Which of the following is an automatic stabilizer?

Unemployment compensation payment to the unemployed auto workers.

Scenario 20-1: Fiscal Policy Consider the economy of Arcadia. The households of Arcadia spend 75% of their income. There are no taxes and no foreign trade. The currency of Arcadia is called "Arcs". The level of potential output in Arcadia is 600 billion arcs. Use Scenario 20-1. Refer to the information provided. Suppose the actual real GDP in Arcadia is 500 billion arcs. Then, the economy has:

a recessionary gap.

An example of an automatic stabilizer that works when the economy contracts is:

a rise in government transfers, as more people receive unemployment insurance benefits.

The mechanism that causes government tax revenue to rise and fall with the business cycle is known as:

an automatic stabilizer.

Suppose the economy is currently experiencing a recessionary gap. Which of the following fiscal policy options is most likely to increase real GDP by the largest amount?

an increase in government purchases

Figure 20-9: AD-AS nar007-1.jpg Use the "AD-AS" Figure 20-9. Consider an economy that is producing an output level of Y1. Then the economy is in:

an inflationary gap and contractionary fiscal policy can remove the gap.

Automatic stabilizers act like:

automatic expansionary fiscal policy when the economy is in a recession.

The current level of real GDP lies above potential GDP. An appropriate fiscal policy would be to _____, which will shift the _____ curve to the _____.

decrease government purchases; AD; left.

Figure 20-7: Fiscal Policy Choices nar005-1.jpg Use the "Fiscal Policy Choices" Figure 20-7. In Panel (a), the economy is initially at output level Y1 and there is:

a recessionary gap.

Suppose an economy is producing real GDP of $300 billion. The potential output is equal to $400 billion, and the MPC is equal to 0.80. Then the government should follow a policy of:

cutting taxes by $25 billion to take the economy back to potential output.

The current level of real GDP lies below potential GDP. An appropriate fiscal policy would be to _____, which will shift the _____ curve to the _____.

increase government purchases; AD; right.

Discretionary fiscal policy may fail to stabilize the economy or even make the economy less stable due to:

lags in deciding and implementing a policy change.