Deck 15: Government Spending and Its Financing

Question 1

The total spending by government during a period of time includes

A) government purchases of goods and services.
B) transfer payments.
C) interest payments.
D) all of the above.

Answer 1

D

Question 2

The deficit is

A) the amount by which government purchases, transfers, and net interest exceed tax revenues.
B) the amount by which government purchases and transfers exceed tax revenues.
C) the primary deficit minus net interest payments.
D) total tax revenues minus net interest minus government expenditures.

Answer 2

A

Question 3

Since the 1950s, transfer payments' share of GDP has

A) steadily increased.
B) steadily decreased.
C) remained fairly steady.
D) increased during Liberal governments and decreased during Conservative governments.

Answer 3

A

Question 4

The largest source of tax receipts for the government is

A) direct taxes from persons.
B) investment income.
C) indirect taxes.
D) direct taxes from enterprises.

Question 5

The primary deficit is

A) the amount by which government purchases, transfers, and net interest exceed tax revenues.
B) the amount by which government purchases and transfers exceed tax revenues.
C) the deficit plus net interest payments.
D) total tax revenues minus net interest minus government expenditures.

Question 6

Since the 1950s, the share of GDP devoted to government purchases has

A) steadily increased.
B) steadily decreased.
C) remained fairly steady.
D) increased, but only after recessions.

Question 7

The type of tax receipts that has shown the slowest growth since World War II has been

A) direct taxes from persons.
B) investment income.
C) indirect taxes.
D) direct taxes from enterprises.

Question 8

The primary surplus is equal to

A) tax revenues - expenditures.
B) tax revenues - transfers - net interest - government purchases.
C) revenues - expenditures + net interest.
D) tax revenues - transfers - government purchases.

Question 9

The type of tax receipts that has shown the largest growth since the end of World War II has been

A) direct taxes from persons.
B) investment income.
C) indirect taxes.
D) direct taxes from enterprises.

Question 10

Assume the marginal tax rate for income above $25000 has risen to 30 percent. If the tax rate for the income less than $25000 is 10 percent, how much tax a person with an income of $40,000 will pay?

A) $600
B) $6500
C) $7000
D) $8000

Question 11

Assume the marginal tax rate for income above $25000 has risen to 30 percent. If the tax rate for the income less than $25000 is 10 percent, what is the average tax rate for a person with an income of $40,000?

A) 15%
B) 16%
C) 17.5%
D) 18%

Question 12

What portion of government purchases of goods and services is carried out by provincial and local governments?

A) one-third
B) one-half
C) two-thirds
D) four-fifths

Question 13

Interest payments by the government as a share of GNP have

A) steadily increased.
B) remained fairly steady.
C) increased, but only to reflect changes in nominal interest rates.
D) increased sharply in the early 1930s, the 1940s and in the 1980s-1990s.

Question 14

According to Keynesian economists, the primary problem with using fiscal policy as a stabilization tool is that

A) fiscal policy does not have the effect on output in practice that it should have in theory.
B) fiscal policy will be effective only if it is funded through lump-sum tax changes.
C) fiscal policy will be effective only if it is funded through permanent changes in taxes.
D) fiscal policy is inflexible because a large portion of government spending is planned years in advance and cannot easily be changed.

Question 15

The political process by which fiscal policy is made

A) is relatively rapid, contributing to the effectiveness of fiscal policy.
B) requires only that the prime minister approve changes to the budget, a decision that takes several months.
C) is efficient in reaching a decision within a year.
D) is slow and results in a long time lag for fiscal policy.

Question 16

Which of the following is not included in the government transfer payments?

A) Old age security payments
B) Foreign aids
C) Employment insurance benefits
D) Intergovernmental payments

Question 17

Which of the following would not act as an automatic stabilizer?

A) unemployment insurance
B) government purchases
C) personal income taxes
D) corporate income taxes

Question 18

The main sources of the Canadian government income are

A) direct and indirect taxes.
B) foreign investment.
C) investment income.
D) both A and C.

Question 19

Classical economists think that lump-sum tax changes

A) should be used to smooth business cycles.
B) have a powerful effect on the economy.
C) affect aggregate demand after a lag.
D) have no effect because of Ricardian equivalence.

Question 20

Provincial and local governments rely on ________ as their primary source of tax receipts.

A) direct taxes from persons
B) investment income
C) indirect taxes
D) direct taxes from enterprises

Question 21

What is the difference between the average and marginal tax rates effects on the labour supply?

A) An increase in the average tax rate will increase labour supply, but an increase in the marginal tax rate will decrease labour supply.
B) An increase in the average tax rate will decrease labour supply, but an decrease in the marginal tax rate will decrease labour supply.
C) There is no difference. An increase in the average tax rate and the marginal tax rate will increase labour supply.
D) There is no difference. An increase in the average tax rate and the marginal tax rate will decrease labour supply.

Question 22

Suppose that all workers place a value on their leisure of 75 goods per day. The production function relating output per day Y to the number of people working per day N is Y = 500N - 0.4N² and the marginal product of labour is MPN = 500 - 0.8 N. A 25% tax is levied on wages. Output per day would be

A) 100,000.
B) 150,000.
C) 200,000.
D) 250,000.

Question 23

The average cost of the distortion created by taxes

A) increases proportionately with the tax rate.
B) is lower when the tax rate is constant than when it fluctuates.
C) is higher when the tax rate is constant than when it fluctuates.
D) equals the square root of the tax rate.

Question 24

Government capital consists of

A) money owned by the government.
B) securities owned by the government.
C) the buildings owned by the government in Ottawa.
D) long-lived physical assets owned by the government.

Question 25

Because of automatic stabilizers, in recessions the government budget deficit ________, while in expansion the deficit ________.

A) falls; rises
B) falls; falls
C) rises; falls
D) rises; rises

Question 26

A decrease in the marginal tax rate, with the average tax rate held constant, will

A) increase the amount of labour supplied at any real wage.
B) not affect the amount of labour supplied at any real wage.
C) decrease the amount of labour supplied at any real wage.
D) increase the amount of labour supplied at any real wage if the average tax rate is above the marginal tax rate, but decrease the amount of labour supplied at any real wage if the average tax rate is below the marginal tax rate.

Question 27

All of the following are government capital except

A) roads.
B) schools.
C) Treasury securities.
D) mass-transit systems.

Question 28

Roads and education are examples of

A) government physical and human capital formation, respectively.
B) government human and physical capital formation, respectively.
C) government spending on current items.
D) government subsidies.

Question 29

Which of the following is true about the actual and structural budget surplus in Canada?

A) The actual budget surplus was significantly less than the structural budget surplus during the last three recessions reflecting the importance of automatic stabilizers.
B) The actual budget surplus was significantly larger than the structural budget surplus during the last three recessions reflecting the importance of automatic stabilizers.
C) The actual budget surplus was not significantly different than the structural budget surplus during the last three recessions indicating that the automatic stabilizers were not important.
D) The actual budget surplus was not significantly different than the full-employment budget surplus during the last three recessions indicating that the automatic stabilizers were not important.

Question 30

The average tax rate is

A) the fraction of an additional dollar of income that must be paid in taxes.
B) the total amount of taxes paid divided by after-tax income.
C) the total amount of taxes paid divided by before-tax income.
D) the average amount of government spending that is financed by taxes.

Question 31

Assume that the lost output due to tax distortions is proportional to the square of the tax rate. If the government increased the tax rate from 25% to 40%, the lost output would increase by a factor of

A) 1.56.
B) 1.60.
C) 1.96.
D) 2.56.

Question 32

The full-employment deficit is

A) the number of jobs needed to restore full employment.
B) what the government budget deficit would be if the economy were at full employment.
C) the increase in government spending that would be needed to return the economy to full employment.
D) the extra amount paid to government workers in a recession.

Question 33

An example of tax smoothing is provided by evidence of

A) temporary changes in defense expenditures by the government.
B) reductions in tax rates prior to elections.
C) Keynesian tax cuts designed to help the economy recover from a recession.
D) reliance on debt financing rather than taxation during World War II.

Question 34

Taxes distort economic behaviour because

A) they change the composition of income and spending.
B) they cause deviations in economic behaviour from the efficient, free-market outcome.
C) they change the balance between private and public expenditures.
D) they change the composition of consumption, investment, government spending, and net exports.

Question 35

Suppose that all workers place a value on their leisure of 75 goods per day. The production function relating output per day Y to the number of people working per day N is Y = 500N - 0.4N² and the marginal product of labour is MPN = 500 - 0.8 N. A 25% tax is levied on wages. In terms of lost output, what is the cost of the distortion introduced by this tax?

A) 63
B) 531
C) 2734
D) 3751

Question 36

Assume that the lost output due to tax distortions is proportional to the square of the tax rate. If the average cost of the distortion created by taxes is currently $100, and the tax rate is increased from 20% to 50%, the average cost of the distortion created by taxes will increase to

A) $169.
B) $225.
C) $250.
D) $625.

Question 37

A decrease in the average tax rate, with the marginal tax rate held constant, will

A) increase the amount of labour supplied at any real wage.
B) not affect the amount of labour supplied at any real wage.
C) decrease the amount of labour supplied at any real wage.
D) increase the amount of labour supplied at any real wage if the average tax rate is above the marginal tax rate, but decrease the amount of labour supplied at any real wage if the average tax rate is below the marginal tax rate.

Question 38

Which of the following statements about the structural surplus or cyclically adjusted surplus is true?

A) An expansionary fiscal policy lowers the structural surplus.
B) An increase in tax rates raises the structural surplus.
C) A contractionary fiscal policy raises the structural surplus.
D) A and C.

Question 39

The marginal tax rate is

A) the fraction of an additional dollar of income that must be paid in taxes.
B) the total amount of taxes paid divided by after-tax income.
C) the total amount of taxes paid divided by before-tax income.
D) the average amount of government spending that is financed by taxes.

Question 40

In general,

A) the higher the marginal tax rate already is, the greater are the additional distortions created by raising the marginal tax rate still further.
B) the higher the marginal tax rate already is, the smaller are the additional distortions created by raising the marginal tax rate still further.
C) the higher the average tax rate already is, the smaller are the additional distortions created by raising the average tax rate still further.
D) the higher the average tax rate and the marginal tax rate, the smaller are the additional distortions created by raising the marginal and average tax rates still further.

Question 41

Seignorage is the revenue a government raises by

A) taxation.
B) printing money.
C) borrowing money.
D) charging fees for services.

Question 42

The debt-GDP ratio in Canada

A) steadily fell after World War II.
B) steadily increased after World War II.
C) fell from the end of World War II until around 1976 and rose thereafter.
D) fell from the end of World War II until around 1976 and rose thereafter, until 1996.

Question 43

Increases in the debt-GDP ratio are primarily caused by

A) a high growth rate of GDP.
B) a high primary government deficit.
C) increases in government.
D) increases in interest rates.

Question 44

Economists prefer tax rate smoothing because

A) it minimizes distortions.
B) it eliminates distortions.
C) it is beneficial to poor.
D) it maximizes government tax revenues.

Question 45

Which of the following can explain the Canada's unprecedented high debt-GDP ratio between 1975 and 1995?

A) Canada experienced a combination of low interest rate payable on government debt and a high economic growth.
B) Canada experienced a combination of high interest rate payable on government debt and a slow economic growth.
C) Canada experienced a combination of low interest rate payable on government debt and a slow economic growth.
D) Canada experienced a combination of high interest rate payable on government debt and a high economic growth.

Question 46

The DEBTLAND's economic growth is 5 percent and the interest rate paid on debt is also 5 percent. If the primary deficit to GDP ratio is 2 percent, the DEBTLAND's debt-GDP ratio will change by

A) 3 percent.
B) 5 percent.
C) 7 percent.
D) 2 percent.

Question 47

In 2004, The DEBTLAND's debt-GDP ratio was 0.7, and in 2005, the government primary deficit to GDP ratio is -0.2. If the interest rate paid on debt is 4 percent and the economy grow by 4 percent in 2005, the DEBTLAND's debt-DGP ratio in 2005 will

A) increase by 20 percent.
B) decrease by 20 percent.
C) increase by 4 percent.
D) not change.

Question 48

An expansionary fiscal policy will not cause an increase in the price level if the government

A) reduces the corporate income tax rate.
B) increases purchases in the classical model.
C) lowers taxes and Ricardian equivalence does not hold.
D) lowers taxes and Ricardian equivalence holds.

Question 49

An increased government deficit created by a lump-sum tax cut will reduce national saving if

A) the value of government bonds outstanding grows faster than the public's wealth.
B) it causes consumption to rise.
C) the government runs a primary deficit as a result.
D) the real interest rate is greater than the growth rate of real GNP.

Question 50

Which of the following would be most likely to increase consumption in the economy?

A) a lump-sum tax cut
B) a tax break for saving account
C) a cut in sales taxes
D) a cut in the corporate tax rate

Question 51

The real seignorage collected by the government is the product of

A) the rate of inflation and the real supply of government bonds.
B) the rate of inflation and the real money supply.
C) the debt/GDP ratio and the real money supply.
D) the debt/GDP ratio and the rate of inflation.

Question 52

The DEBTLAND's debt-GDP ratio in 2004 was 0.7, but it went down by 20 percent in 2005. If the interest rate paid on debt is 4 percent and the economy grow by 4 percent in 2005, the DEBTLAND's primary deficit to GDP ratio must

A) have increased by 20 percent.
B) have decreased by 20 percent.
C) have remained unchanged.
D) have decreased by 4 percent.

Question 53

According to the Ricardian equivalence proposition, current deficits

A) will not affect consumption or national saving.
B) will affect consumption but not national saving.
C) will affect national saving but not consumption.
D) will affect both consumption and national saving.

Question 54

Given a stable primary deficit to GDP ratio, Canada can reduce its dept-GDP ratio, if

A) the economic growth is higher than the interest rate paid on debt.
B) the economic growth is lower than the interest rate paid on debt.
C) the economic growth is the same as the interest rate paid on debt.
D) the economic growth is higher than the inflation rate.

Question 55

All else constant, if the interest rate paid on government debt falls short of the GDP growth rate,

A) the debt-GDP ratio will rise from one year to the next.
B) the debt-GDP ratio will fall from one year to the next.
C) the debt-GDP ratio will remain unchanged from one year to the next.
D) the debt will rise more than the GDP growth rate from one year to the next.

Question 56

A decrease in taxes on the current generation would have no effect on consumption or national saving if

A) individuals face borrowing constraints.
B) individuals increase their consumption by less than the tax cut.
C) consumers bequeath all of the tax cut to the next generation.
D) consumers are not forward looking concerning their future tax burden.

Question 57

In which case would you be most likely to expect inflation to occur?

A) The government runs a sustained government deficit by lowering taxes.
B) The government runs a sustained government deficit by increasing purchases.
C) The government runs a sustained primary deficit by increasing purchases.
D) The government funds its sustained deficit by increasing the money supply.

Question 58

Which of the following would not be an argument that government debt imposes a burden on future generations?

A) Lump-sum taxes in the future may be raised to pay higher real interest costs.
B) Higher taxes in the future could increase the average cost of distortions to the economy created by taxes.
C) Higher taxes in the future to repay government debt will transfer resources from the poor to the rich.
D) Higher government deficits resulting from increased purchases may reduce savings, causing investment to fall.

Question 59

Deficits are a burden on future generations if

A) they cause higher rates of inflation to occur.
B) they are not used for government capital formation.
C) they cause national saving to fall.
D) they are always a primary government deficit.

Question 60

Generational accounts show how much each generation

A) contributes to government capital.
B) saves.
C) earns relative to the income of other generations.
D) pays in taxes as a function of lifetime income.

Question 61

Real money demand in the economy is given by L = 0.3Y - 600 i, where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 2000 and the real interest rate is 5%. At what rate of inflation is seignorage maximized?

A) 42.5%
B) 45.0%
C) 47.5%
D) 50.0%

Question 62

Consider an economy that has the following monetary data: Currency in circulation = $300
Bank reserves = $50
Monetary base = $350
Deposits = $700
Money supply = $1000
The monetary base and the money supply are expected to grow at a constant rate of 20% per year. Inflation and expected inflation are 20% per year. Suppose that bank reserves and currency pay no interest, all currency is held by the public, and bank deposits pay no interest. What is the profit to the banks from the inflation?

A) $130
B) $140
C) $190
D) $200

Question 63

What are the main reasons (give at least three) that Ricardian equivalence might not hold?

Question 64

Whether real seignorage revenue increases when the rate of money growth increases depends on whether

A) the rise in real money holdings outweighs the decline in inflation.
B) the rise in inflation outweighs the decline in real money holdings.
C) the rise in inflation ratio outweighs the decline in the real supply of currency.
D) the rise in the real supply of currency outweighs the decline in inflation.

Question 65

At the beginning of year one, there is no government debt outstanding. The government runs a $100 billion deficit in year one. Interest at a nominal rate of 10% must be paid starting in year two. Assume nominal GDP in year one is $2000 billion and the nominal growth rate of GDP is 4%. Assume the government balances its primary budget in the future and the interest rate and growth rate do not change.
a. What will be the government deficit in years two, three, four, and five?
b. What will be the value of government bonds outstanding at the end of the fifth year?
c. What will be the debt-GDP ratio at the end of year five?

Question 66

How is real seignorage revenue related to inflation? How does the quantity of real seignorage revenue change as inflation rises from zero to a positive level, to still higher levels?

Question 67

Consider an economy that has the following monetary data: Currency in circulation = $300
Bank reserves = $50
Monetary base = $350
Deposits = $700
Money supply = $1000
The monetary base and the money supply are expected to grow at a constant rate of 20% per year. Inflation and expected inflation are 20% per year. Suppose that bank reserves and currency pay no interest, all currency is held by the public, and bank deposits pay no interest. What is the cost to the public of the inflation tax?

A) $60
B) $140
C) $190
D) $200

Question 68

Real money demand in the economy is given by L = 0.3Y - 600 i, where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 2000 and the real interest rate is 5%. What is the maximum amount of seignorage revenue?

A) 132,000
B) 135,375
C) 138,000
D) 141,125

Question 69

Consider an economy that has the following monetary data:
Currency in circulation = $300
Bank reserves = $50
Monetary base = $350
Deposits = $700
Money supply = $1000
The monetary base and the money supply are expected to grow at a constant rate of 20% per year. Inflation and expected inflation are 20% per year. Suppose that bank reserves and currency pay no interest, all currency is held by the public, and bank deposits pay no interest.
a. What is the cost to the public of the inflation tax?
b. What is the nominal value of seignorage over the year?
c. What is the profit to the banks from the inflation?

Question 70

Suppose that all workers place a value on their leisure of 75 goods per day. The production function relating output per day Y to the number of people working per day N is Y = 500N - 0.4N², and the marginal product of labour is MPN = 500 - 0.8 N. A 25% tax is levied on wages.
a. How much is output per day?
b. In terms of lost output, what is the cost of the distortion introduced by this tax?

Question 71

You are given the following budget data for a country that has both a central government and local governments:
Central purchases of goods 500
Local purchases of goods 250
Central transfer payments 200
Local transfer payments 100
Grants in aid (central to local) 150
Central tax receipts 800
Local tax receipts 150
Interest received from private sector by central government 25
Interest received from private sector by local governments 10
Total central government debt 1500
Total local government debt 0
Central government debt held by local governments 300
Nominal interest rate 10%
a. How much is the deficit for the central government, the local government, and the total of the central and local governments?
b. How much is the primary deficit for the central government, the local government, and the total of the central and local governments?

Question 72

Why should government smooth tax rates? If they do so, what happens to deficits over the business cycle?

Question 73

Who bears the burden of the government debt? Explain why. Under what circumstances is there no burden to be borne?

Question 74

The SPENDLAND's GDP and debt last year was $4000 billion and $2000 billion, respectively. This year, the government revenue is $800 billion and the government expenditure is $1000 billion. Suppose the interest rate payable on government debt is 10 percent.
a. What is the debt-GDP ratio for last year? This year?
b. How much did the debt-GDP ratio change?
c. Explain why the debt-GDP ratio changed?

Question 75

Real money demand in the economy is given by L = 0.3Y - 600i, where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 2000 and the real interest rate is 5%.
a. At what rate of inflation is seignorage maximized?
b. What is the maximum amount of seignorage revenue?

Question 76

Suppose that for the economy of Chou,
Tax revenues = 2000 + 0.1 GDP
Transfers = 1500 + 0.05 GDP
Government purchases = 3000
Interest payments = 200
Full employment GDP = 15,000
Actual GDP = 16,000
a. How much is the budget deficit?
b. How much is the primary budget deficit?
c. How much is the full-employment budget deficit?

Question 77

Assume that the real interest rate is 4%, the expected rate of inflation is 8%, and the nominal interest rate is 12%. The monetary base equals $50 billion. The real seignorage revenue collected by the government would equal

A) $4 billion.
B) $6 billion.
C) $8 billion.
D) $12 billion.