Deck 16: The Influence of Fiscal Policy on Aggregate Demand

Question 1

Which term refers to the positive feedback from aggregate demand to investment?

A) investment multiplier
B) catch-up effect
C) investment accelerator
D) crowding-in multiplier

Answer 1

investment accelerator

Question 2

If an individual's income increases from $500 to $700 and their spending increases by $150, what is the marginal propensity to consume?

A) 0.75
B) 1.25
C) 4
D) 50

Answer 2

0.75

Question 3

Which of the following tends to make aggregate demand shift right farther than the amount that government expenditures increase?

A) the crowding-out effect
B) the multiplier effect
C) the wealth effect
D) the investment accelerator effect

Answer 3

the multiplier effect

Question 4

What is the term for the fraction of extra income that a household consumes rather than saves?

A) the marginal propensity to consume
B) the total propensity to consume
C) the average consumption
D) the marginal tax rate

Question 5

Which of the following best defines the multiplier effect?

A) the multiplied impact on the money supply of a given increase in government purchases
B) the multiplied impact on tax revenues of a given increase in government purchases
C) the multiplied impact on investment of a given increase in interest rates
D) the multiplied impact on aggregate demand of a given increase in government purchases

Question 6

Fiscal policy refers to the idea that aggregate demand is changed by changes in what?

A) the money supply
B) government spending and taxes
C) trade policy
D) interest rates

Question 7

Assume that the MPC is 0.9. What is the multiplier?

A) 0.1
B) 1.1
C) 9
D) 10

Question 8

A decrease in government spending initially and primarily shifts which curve in what direction?

A) aggregate demand right
B) aggregate demand left
C) aggregate supply right
D) aggregate supply left

Question 9

If the MPC = 0.8, what is the government purchases multiplier?

A) 0.20
B) 0.50
C) 2
D) 5

Question 10

If the MPC is 0.6, what is the multiplier?

A) 0.4
B) 1.67
C) 2.5
D) 60

Question 11

Which of the following shifts aggregate demand right?

A) an increase in government expenditures or a decrease in the price level
B) a decrease in government expenditures or an increase in the price level
C) an increase in government expenditures, but not a change in the price level
D) a decrease in the price level, but not an increase in government expenditures

Question 12

Which statement best illustrates how the investment accelerator works for the Sleepwell Hotel chain?

A) an increase in government expenditures increases the interest rate so that the chain decides to build fewer new hotels
B) an increase in government expenditures increases aggregate spending so that the chain finds it profitable to build more new hotels
C) an increase in government expenditures increases the interest rate so that the demand for stocks and bonds issued by the chain rises
D) an increase in government expenditures decreases the interest rate so that the chain decides to build more new hotels

Question 13

If the MPC = 3/4, what is the government purchases multiplier?

A) 1/4
B) 3/4
C) 4/3
D) 4

Question 14

If an individual's income increases from $500 to $700 and their spending increases by $120, what is the marginal propensity to consume?

A) 0.6
B) 1.67
C) 2.5
D) 60

Question 15

A city decides to build a new hockey arena. The owner of the construction company that builds the new arena pays their workers. The workers increase their spending. Firms that the workers buy goods from increase their output. What does this type of effect on spending illustrate?

A) the multiplier effect
B) the crowding-out effect
C) the Fisher effect
D) the liquidity preference effect

Question 16

An increase in government spending initially and primarily shifts which curve in what direction?

A) aggregate demand to the right
B) aggregate demand to the left
C) aggregate supply to the right
D) aggregate supply to the left

Question 17

The government buys a bridge. The owner of the company that builds the bridge pays her workers. The workers increase their spending. Firms that the workers buy goods from increase their output. What does this type of effect on spending illustrate?

A) the multiplier effect
B) the crowding-out effect
C) the marginal propensity to consume effect
D) the investment accelerator effect

Question 18

Which of the following best defines the marginal propensity to consume (MPC)?

A) the fraction of extra income that a household consumes rather than saves
B) the fraction of extra income that a household either consumes or saves
C) the fraction of total income that a household consumes rather than saves
D) the fraction of total income that a household either consumes or saves

Question 19

Which of the following defines the government purchases multiplier?

A) 1/MPC+ MPI
B) 1/(1 - MPC)
C) MPC/(1 - MPC)
D) (1 - MPC)/MPC

Question 20

What does fiscal policy primarily affect in the short run?

A) growth
B) investment
C) aggregate demand
D) aggregate supply

Question 21

Assuming no crowding-out, investment-accelerator, or multiplier effects, how will a $100 billion increase in government expenditures shift aggregate demand?

A) It will shift aggregate demand right by more than $100 billion.
B) It will shift aggregate demand right by $100 billion.
C) It will shift aggregate demand right by less than $100 billion.
D) It will shift aggregate demand left by more than $100 billion.

Question 22

How does the multiplier change when the MPC increases, and what is the effect on aggregate demand?

A) Higher MPC increases the multiplier so that changes in government expenditures have a larger effect on aggregate demand.
B) Higher MPC increases the multiplier so that changes in government expenditures have a smaller effect on aggregate demand.
C) Higher MPC decreases the multiplier so that changes in government expenditures have a larger effect on aggregate demand.
D) Higher MPC decreases the multiplier so that changes in government expenditures have a smaller effect on aggregate demand.

Question 23

Assuming the multiplier effect but no crowding-out or investment-accelerator effects, what is the effect of a $500 billion increase in government expenditures on the aggregate demand?

A) It shifts the aggregate demand right by more than $500 billion.
B) It shifts the aggregate demand right by less than $500 billion.
C) It shifts the aggregate demand left by more than $500 billion
D) It shifts the aggregate demand left by less than $500 billion.

Question 24

If the MPC = 0.5 and the MPI = 0.3, what is the government purchases multiplier in an open economy?

A) 1.25
B) 2
C) 4
D) 5

Question 25

If the MPC is 0.8 and government increases spending by $50 million, what will be the demand for goods and services generated by this increase?

A) $10 million
B) $40 million
C) $62.5 million
D) $250 million

Question 26

If the MPC is 0.6, the MPI is 0.2, and the government increases spending by $50 million, what will be the demand for goods and services generated by this increase?

A) $30 million
B) $40 million
C) $125 million
D) $250 million

Question 27

Which statement best explains the crowding-out effect?

A) An increase in government expenditures decreases the interest rate and so increases investment spending.
B) An increase in government expenditures increases the interest rate and so reduces investment spending.
C) A decrease in government expenditures increases the interest rate and so increases investment spending.
D) A decrease in government expenditures decreases the interest rate and so reduces investment spending.

Question 28

Which of the following defines the government purchases multiplier in an open economy?

A) 1/MPC + MPI
B) 1/(1 - MPC - MPI)
C) MPC/(1 - MPC)
D) (1 - MPC)/MPC

Question 29

According to the crowding-out effect, how does a decrease in government spending affect the interest rate and investment spending?

A) It increases the interest rate and so increases investment spending.
B) It increases the interest rate and so decreases investment spending.
C) It decreases the interest rate and so increases investment spending.
D) It decreases the interest rate and so decreases investment spending.

Question 30

Which term refers to the reduction in demand that results when a fiscal expansion raises the interest rate?

A) multiplier effect
B) crowding-out effect
C) accelerator effect
D) catch-up effect

Question 31

If the MPC = 0.6 and the MPI = 0.25, what is the government purchases multiplier in an open economy?

A) 1.8
B) 2.5
C) 4
D) 6.7

Question 32

If the multiplier is 5, what is the MPC?

A) 0.20
B) 0.50
C) 0.80
D) 1.00

Question 33

If the MPC is 0, what is the multiplier?

A) 0
B) 1
C) 10
D) 100

Question 34

As the MPC gets close to 1, what does the value of the multiplier approach?

A) 0
B) 1
C) 10
D) infinity

Question 35

If the MPC is 0.6 and government increases spending by $50 million, what will be the demand for goods and services generated by this increase?

A) $20 million
B) $30 million
C) $83.3 million
D) $125 million

Question 36

If the MPC is 0.4, the MPI is 0.2, and the government increases spending by $50 million, what will be the demand for goods and services generated by this increase?

A) $20 million
B) $30 million
C) $125 million
D) $250 million

Question 37

If the multiplier is 10, what is the MPC?

A) 1/9
B) 1/5
C) 4/5
D) 9/10

Question 38

If there is crowding out, which of the following might decrease as government expenditures increase?

A) the overall change in real GDP
B) the demand for money curve
C) interest rates
D) the demand for capital goods

Question 39

What is an effect of an increase in government purchases?

A) It decreases interest rates.
B) It results in a decrease in the government deficit.
C) It crowds out investment spending by business.
D) It decreases money demand.

Question 40

According to the crowding-out effect, how do the interest rate and investment spending change when government spending increases?

A) The interest rate and investment spending both increase.
B) The interest rate increases and investment spending decreases.
C) The interest rate decreases and investment spending increases.
D) The interest rate and investment spending both decrease.

Question 41

Assume that the MPC is 0.8. Assuming that only the multiplier effect matters, how will a decrease in government purchases of $150 billion shift the aggregate demand curve?

A) It will shift the aggregate demand curve left by $120 billion.
B) It will shift the aggregate demand curve left by $150 billion.
C) It will shift the aggregate demand curve right by $150 billion.
D) It will shift the aggregate demand curve left by $750 billion.

Question 42

In a small open economy with perfect capital mobility, if the Bank of Canada chooses to fix the value of the Canadian dollar, what will a contractionary monetary policy do?

A) It will have no effect.
B) It will shift the AD curve to the left.
C) It will shift the AD curve to the right.
D) It will shift both the AD curve and the short-run AS curve to the left.

Question 43

In a small open economy with a flexible exchange rate, what will an expansionary fiscal policy cause?

A) the dollar to depreciate
B) the dollar to appreciate
C) net exports to increase
D) a lasting effect on aggregate demand

Question 44

Assume that the MPC is 0.75. Assuming only the multiplier effect matters, how will an increase in government purchases of $200 billion shift the aggregate demand curve?

A) It will shift the aggregate demand curve left by $80 billion.
B) It will shift the aggregate demand curve left by $250 billion.
C) It will shift the aggregate demand curve right by $750 billion.
D) It will shift the aggregate demand curve right by $800 billion.

Question 45

If the MPC is 0.75 and there are no crowding-out or accelerator effects, an initial increase in AD of $100 billion will eventually shift the AD curve to the right by how much?

A) $40 billion
B) $133.33 billion
C) $250 billion
D) $400 billion

Question 46

In a small open economy with a flexible exchange rate, what will an expansionary fiscal policy cause?

A) It will cause the dollar to depreciate.
B) It will cause net exports to rise.
C) It will cause an additional investment accelerator effect.
D) It will cause a reduction in the demand for Canadian-produced goods.

Question 47

Canada is a small open economy with a flexible exchange rate. Which effect will a contractionary fiscal policy have?

A) It will cause the Canadian interest rate to fall below the world interest rate for a short period of time, which in turn will cause the dollar to depreciate and net exports to increase.
B) It will cause the Canadian interest rate to rise above the world interest rate for a short period of time, which in turn will cause the dollar to appreciate and net exports to decrease.
C) It will cause the Canadian interest rate to fall below the world interest rate for a short period of time, which in turn will cause the dollar to appreciate and net exports to decrease.
D) It will cause the Canadian interest rate to rise above the world interest rate for a short period of time, which in turn will cause the dollar to depreciate and net exports to increase.

Question 48

Assume that the MPC is 0.8. Assume that there is a multiplier effect and that the total crowding-out effect is $8 billion. How will an increase in government purchases of $10 billion shift aggregate demand?

A) It will shift aggregate demand left by $2 billion.
B) It will shift aggregate demand left by $42 billion.
C) It will shift aggregate demand right by $2 billion.
D) It will shift aggregate demand right by $42 billion.

Question 49

If the Bank of Canada maintains a fixed exchange rate, which effect will an expansionary fiscal policy have?

A) It will cause a large and permanent rightward shift in the AD curve.
B) It will cause a large and permanent leftward shift in the AD curve.
C) It will have no permanent effect on the position of the AD curve, but it will cause interest rates to rise.
D) It will have no permanent effect on either the position of the AD curve or the interest rate.

Question 50

Figure 16-1
Refer to Figure 16-1. In a closed economy, what would cause the aggregate demand curve to shift from AD to AD*?

A) an increase in government purchases
B) a decrease in stock prices
C) an increase in consumer and firm optimism about the future
D) an increase in the price level

Question 51

How do the multiplier effect and the crowding-out effect change the consequences of an increase in government spending?

A) They both amplify the consequences.
B) They both diminish the consequences.
C) The multiplier effect diminishes the consequences, while the crowding-out effect amplifies the consequences.
D) The multiplier effect amplifies the consequences, while the crowding-out effect diminishes the consequences.

Question 52

If the Bank of Canada chooses to prevent any change in the exchange rate when government spending increases, what is most likely to happen?

A) crowding-out effects
B) no crowding-out effects
C) no increase in the demand for goods and services
D) a decrease in aggregate demand

Question 53

In a small open economy with perfect capital mobility, if the exchange rate is flexible, what would be the effect of an expansionary monetary policy?

A) It would cause the domestic interest rate to increase permanently.
B) It would cause the domestic interest rate to decrease permanently.
C) It would cause the domestic interest rate to increase temporarily.
D) It would cause the domestic interest rate to decrease temporarily.

Question 54

Figure 16-1
Refer to Figure 16-1. In a closed economy, what could have caused the economy to move from a to b?

A) a wave of optimism
B) a decrease in price
C) either fiscal or monetary contraction
D) an increase in the price of oil

Question 55

Figure 16-1
Refer to Figure 16-1. If the closed economy is at point b, which of the following is the best policy to restore full employment?

A) increasing the money supply
B) decreasing government purchases
C) increasing taxes
D) selling Canadian dollars

Question 56

Assume that the MPC is 0.8. Assume that the total crowding-out effect is $20 billion. How will an increase in government purchases of $9 billion shift the AD curve?

A) It will shift the AD curve right by $25 billion.
B) It will shift the AD curve left by $25 billion.
C) It will shift the AD curve right by $20 billion.
D) It will shift the AD curve left by $20 billion

Question 57

If the Bank of Canada allows the exchange rate to vary freely, which effect will an expansionary fiscal policy have?

A) It will cause a large and permanent rightward shift of the AD curve.
B) It will cause a large and permanent leftward shift of the AD curve.
C) It will have no permanent effect on the position of the AD curve, but it will cause interest rates to permanently increase.
D) It will have no permanent effect on either the position of the AD curve or the interest rate.

Question 58

In a small open economy with perfect capital mobility, if exchange rates are fixed, how could aggregate demand be increased?

A) by increasing government expenditures
B) by increasing tax rates
C) by increasing the money supply
D) by decreasing the money supply

Question 59

Suppose that the MPC is 0.5 and there is no investment accelerator or crowding-out effects. If government expenditures increase by $200 billion, what happens to aggregate demand?

A) It shifts right by $200 billion.
B) It shifts left by $200 billion.
C) It shifts right by $400 billion.
D) It shifts left by $400 billion.

Question 60

Assuming the crowding-out effect but no multiplier or investment-accelerator effects, what is the effect of a $600 billion increase in government expenditures on the aggregate demand or supply?

A) It shifts the aggregate demand right by more than $600 billion.
B) It shifts the aggregate demand right by less than $600 billion.
C) It shifts the aggregate supply left by more than $600 billion.
D) It shifts the aggregate supply left by less than $600 billion.

Question 61

Suppose the closed economy is in long-run equilibrium. Advances in technology shift the long-run aggregate-supply curve $80 billion to the right. Optimistic investors have shifted the aggregate-demand curve $150 billion to the right. In order to stabilize the price level at its original value, the government wants to reduce its spending. If the crowding-out effect is always half of the multiplier effect, and if the MPC equals 0.75, by how much must the government cut its spending?

A) $4 billion
B) $40 billion
C) $75 billion
D) $150 billion

Question 62

What do supply-side economists believe a reduction in the tax rate will cause?

A) a large shift of the aggregate-supply curve to the left
B) a large shift of the aggregate-supply curve to the right
C) a small shift of the aggregate-supply curve to the right
D) a small shift of the aggregate-supply curve to the left

Question 63

What tends to make the size of a shift in aggregate demand resulting from a tax change smaller than otherwise?

A) multiplier effect
B) crowding-out effect
C) catch-up effect
D) Fisher effect

Question 64

If households view a tax cut as being temporary, how does the tax cut affect aggregate demand?

A) It has no effect on aggregate demand.
B) It has a stronger effect on aggregate demand than if households view the cut as permanent.
C) It has the same effect on aggregate demand than if households view the cut as permanent.
D) It has a weaker effect on aggregate demand than if households view the cut as permanent.

Question 65

According to most economists, what does fiscal policy affect?

A) only aggregate demand and not aggregate supply
B) mostly aggregate demand
C) mostly aggregate supply
D) only aggregate supply and not aggregate demand

Question 66

What are the effects of a change in taxes on consumption and aggregate demand?

A) If taxes increase, consumption increases and aggregate demand shifts right.
B) If taxes increase, consumption decreases and aggregate demand shifts left.
C) If taxes decrease, consumption increases and aggregate demand shifts left.
D) If taxes decrease, consumption decreases and aggregate demand shifts right.

Question 67

How do tax cuts and government expenditure affect aggregate demand?

A) Both shift aggregate demand right.
B) Both shift aggregate demand left.
C) Tax cuts shift aggregate demand right; government expenditure shifts aggregate demand left.
D) Tax cuts shift aggregate demand left; government expenditure shifts aggregate demand right.

Question 68

Suppose the closed economy is in long-run equilibrium. Pessimism on the part of investors then shifts the aggregate-demand curve $50 billion to the left. The government wants to increase spending in order to avoid a recession. If the crowding-out effect is always half as strong as the multiplier effect, and if the MPC equals 0.9, by how much do government purchases have to rise?

A) $10 billion
B) $20 billion
C) $50 billion
D) $100 billion

Question 69

Fiscal policy can have different effects depending whether the exchange rate is fixed or flexible. Who sets the Canadian exchange rate policy?

A) the U.S. Federal Reserve Bank
B) the Royal Bank of Canada
C) the Bank of Canada
D) the Toronto Stock Exchange

Question 70

How do permanent tax cuts shift the AD curve compared with temporary tax results?

A) Permanent tax cuts shift the AD curve farther to the right than temporary tax cuts do.
B) Permanent tax cuts shift the AD curve less to the right than temporary tax cuts do.
C) Permanent tax cuts shift the AD curve farther to the left than temporary tax cuts do.
D) Permanent tax cuts shift the AD curve less to the left than temporary tax cuts do.

Question 71

According to most economists, what will a cut in tax rates do?

A) increase government tax revenue
B) decrease significantly the hours people work
C) have a smaller effect on the aggregate-supply curve than what supply-side economists believe
D) increase tax revenue by increasing worker effort

Question 72

What effects do supply-side economists believe that lowering taxes have?

A) It lowers aggregate demand and increases aggregate supply.
B) It lowers both aggregate demand and aggregate supply.
C) It increases both aggregate demand and aggregate supply.
D) It increases aggregate demand and decreases aggregate supply.

Question 73

Suppose the closed economy is in long-run equilibrium. Immigration of skilled workers shifts the long-run aggregate supply curve $60 billion to the right. At the same time, government purchases increase by $40 billion. If the MPC equals 0.75 and the crowding-out effect is $160 billion, what would we expect to happen in the long-run to real GDP and the price level?

A) Both real GDP and the price level would be higher.
B) Both real GDP and the price level would be lower.
C) Real GDP would be higher, but the price level would be lower.
D) Real GDP would be higher, but the price level would be the same.

Question 74

According to supply-side theories, what happens if the government cuts the tax rate?

A) Workers keep less of each additional dollar they earn, so work effort increases, and aggregate supply shifts right.
B) Workers keep less of each additional dollar they earn, so work effort decreases, and aggregate supply shifts left.
C) Workers keep more of each additional dollar they earn, so work effort increases, and aggregate supply shifts right.
D) Workers keep more of each additional dollar they earn, so work effort decreases, and aggregate supply shifts left.

Question 75

Suppose the closed economy is in long-run equilibrium. Technological change shifts the long-run aggregate-supply curve $80 billion to the right. At the same time, government purchases increase by $40 billion. If the MPC equals 0.75 and the crowding-out effect is $70 billion, what would we expect to happen in the long-run to real GDP and the price level?

A) Both real GDP and the price level would be higher.
B) Both real GDP and the price level would be lower.
C) Real GDP would be higher but the price level would be lower.
D) Real GDP would be higher but the price level would be the same.

Question 76

The "Coyne Affair," which occurred in 1961, is a good example of which of the following?

A) the coordination problems between fiscal and monetary policy
B) the excess printing of money and it leading to hyperinflation
C) the need for government to set a flexible exchange rate
D) the problem of having too many levels of government

Question 77

Suppose the economy is in long-run equilibrium. Parliament passes regulations that make it more costly to conduct business, so the long-run aggregate-supply curve shifts $80 billion to the left. At the same time, government purchases increase by $60 billion. If the MPC equals 0.8 and the crowding-out effect is $70 billion, what would we expect to happen in the long run to real GDP and the price level?

A) Both real GDP and the price level would be higher.
B) Both real GDP and the price level would be lower.
C) Real GDP would be lower, but the price level would be higher.
D) Real GDP would be lower, but the price level would be the same.

Question 78

When the government reduces taxes, all other things being equal, what will decrease?

A) consumption
B) take-home pay
C) household saving
D) government surplus

Question 79

Suppose the closed economy is in long-run equilibrium. Immigration of skilled workers shifts the long-run aggregate-supply curve $120 billion to the right. At the same time, government purchases increase by $50 billion. If the MPC equals 0.8 and the crowding-out effect is $80 billion, what would we expect to happen in the long run to real GDP and the price level?

A) Both real GDP and the price level would be higher.
B) Both real GDP and the price level would be lower.
C) Real GDP would be higher, but the price level would be lower.
D) Real GDP would be higher, but the price level would be the same.

Question 80

What do supply-side economists focus more on than other economists?

A) how fiscal policy affects consumption
B) the multiplier effect of fiscal policy
C) how fiscal policy affects aggregate supply
D) the accelerator and exchange-rate effects