Economics 252 – Revised Review Questions Chapter 12

(1) Countercyclical discretionary fiscal policy calls for, in normal circumstances:

(a) surpluses during recessions, and deficits during periods of inflation;

(b) deficits during recessions, and surpluses during periods of inflation.

(d) deficits during both recessions and periods of inflation.

(2) If the MPC in an economy is 0.8, government could shift the aggregate demand curve rightward by $100 billion by:

(a) increasing government spending by $25 billion.

(b) increasing government spending by $80 billion.

(d) decreasing taxes by $100 billion.

(3) Suppose that the economy is in the midst of a recession. Which of the following policies would be consistent with expansionary fiscal policy?

(a) Incur a federal surplus and impound the surplus.

(b) A reduction in veterans’ benefits.

(d) A reduction in federal tax rates on personal and corporate income.

(4) Assume that aggregate demand in the economy is excessive, causing demand-pull inflation. Which of the following would be most in accord with appropriate government fiscal policy?

(a) An increase in federal income tax rates.

(b) An increase in the size of income tax exemptions for each dependent.

(d) An increase in federal grants to the states for the construction of new prisons.

(5) In a certain year, the aggregate demand at the current price level consists of $100 billion of consumption, $40 billion of investment, $10 billion of net exports, and $20 billion of government purchases. Full-employment GDP is $200 billion. To obtain full-employment under these condition the government should:

(a) encourage personal saving by increasing the interest rate on government bonds.

(b) decrease government expenditures.

(d) discourage private investment by increasing corporate income taxes.

(6) Which of the following represents the most expansionary fiscal policy?

(a) a $10 billion tax cut.

(b) a $10 billion increase in government spending.

(d) a $10 billion decrease in government spending.

Utilize Figure 1 in answering Questions (7), (8), (9), and (10).

Figure 1

Q(f)

0

(7) In Figure 1, Q(f) is the full-employment output. A contractionary fiscal policy would be most appropriate if the economy’s present aggregate demand curve was:

(a) at AD(0). (b) at AD(1) (c) at AD(2) (d) at AD(3).

(8) In Figure 1, Q(f) is the full-employment output. An expansionary fiscal policy would be most appropriate if the economy’s present aggregate demand curve was:

(a) at AD(0) (b) at AD(2) (c) at AD(3) (d) Above AD(2)

(9) In Figure 1, Q(f) is the full-employment output. If the economy’s current aggregate demand curve is AD(0), it is experiencing:

(a) a positive GDP gap.

(b) a negative GDP gap.

(d) an adverse supply shock.

(10) In Figure 1, Q(f) is the full-employment output. If the economy’s current aggregate demand curve is AD(0), it would be appropriate for the government to:

(a) reduce government expenditures and taxes by equal-size amounts.

(b) reduce government expenditures or increase taxes.

(d) reduce unemployment compensation benefits.

(11) Which of the following fiscal actions would be the most effective in curbing inflation?

(a) Incurring a budget deficit.

(b) Incurring a budget surplus which is used to retire debt held by commercial banks.

(d) Incurring a budget surplus which is used to retire debt held by the public.

(12) A major advantage of the built-in or automatic stabilizers is that they:

(a) simultaneously stabilize the economy and reduce the absolute size of the public debt.

(b) automatically produce surpluses during recessions and deficits during inflations.

(d) guarantee that the federal budget will be balanced.

(13) Which of the following best describes the built-in stabilizers as they function in the U.S.?

(a) The size of the budget deficit remains constant over the business cycle.

(b) Personal and corporate income tax collections automatically fall and transfers and subsidies automatically rise as GDP rises.

(c) Personal and corporate income tax collections and transfers and subsidies all automatically vary inversely with the level of GDP.

(d) Personal and corporate income tax collections automatically rise and transfers and subsidies automatically decline as GDP rises.

(14) Suppose the government purposely changes the economy’s full-employment budget deficit of 3 percent of real GDP to a surplus of 1 percent of real GDP. The government is engaging in a(n):

(a) expansionary fiscal policy.

(b) contractionary fiscal policy.

(d) low-interest rate policy.

(15) The crowding-out effect of expansionary fiscal policy suggests that:

(a) tax increases are paid primarily out of saving and therefore are not an effective fiscal policy device.

(b) increases in government spending financed through borrowing will increase the interest rate and thereby reduce investment.

(d) consumer and investment spending always vary inversely.

Use Table 1 to answer Questions (16) and (17).

Table 1

Actual budget, Full-employment

Percent of GDP budget, percent of GDP

Year (-deficits; + surpluses) (- deficits; + surpluses)

1998 0 0

1999 -3 0

2000 -5 -2

2001 -2 -2

2002 +2 +1

(16) In Table 1, the changes in budget conditions between 1998 and 1999 best reflect:

(a) demand-pull inflation.

(b) an expansionary fiscal policy.

(d) a contractionary fiscal policy.

(17) In Table 1, the changes in the budget conditions between 1999 and 2000 best reflect:

(a) demand-pull inflation.

(b) an expansionary fiscal policy.

(d) a contractionary fiscal policy.

(18) An economist who favors smaller government would recommend:

(a) tax cuts during recession and reductions in government spending during inflation.

(b) tax increases during recession and tax cuts during inflation.

(d) increases in government spending during recession and tax increases during inflation.

(19) If the MPS in an economy is 0.1, government could shift the aggregate demand curve rightward by $40 billion by:

(a) increasing government spending by $4 billion.

(b) increasing government spending by $40 billion.

(d) increasing taxes by $4 billion.

(20) An appropriate fiscal policy for severe demand-pull inflation is:

(a) an increase in government spending.

(b) depreciation of the dollar.

(d) a tax rate increase.

Utilize Figure 2 to answer Questions (21) and (22).

Figure 2

In Figure 2, T(1) and T(2) are Tax Revenue schedules at two alternate tax rates. G is the level of Government Purchases.

(21) In Figure 2, the economy is currently at B, which is the full-employment GDP, and with a Tax Revenue schedule at T(1). This economy has a:

(a) full-employment budget surplus only.

(b) full-employment budget deficit only.

(d) full-employment deficit and an actual budget deficit.

(22) In Figure 2, the economy is currently at A, full-employment GDP is at B, and the Tax Revenue schedule is at T(1). This economy has a:

(a) full-employment budget deficit.

(b) actual budget deficit.

(d) neither a surplus or deficit in the actual budget.

(23) An expansionary U.S. fiscal policy might unintentionally cause demand-pull inflation if:

(a) the dollar unexpectedly appreciates while the expansionary policy is in place.

(b) the dollar unexpectedly depreciates while the expansionary policy is in place.

(d) our trading partners experience recession during the time of the fiscal policy action.

Utilize Figure 3 to answer Questions (24) and (25).

Figure 3

0

Real GDP (billions)

(24) In Figure 3, suppose real GDP is X, and full-employment real GDP is at Y. Appropriate government fiscal policy would be to:

(a) increase taxes.

(b) reduce government spending.

(d) reduce taxes or increase government spending.

(25) In Figure 3, suppose real GDP is X, and full-employment real GDP is at Y. If the economy’s MPC is 0.75, X is $100 billion and full-employment real GDP at Y is $140 billion, an appropriate fiscal policy would be to:

(a) reduce taxes by $100 billion.

(b) increase government expenditures by $100 billion.

(d) increase government expenditures by $10 billion.