Question 1

ʺAutomatic fiscal stabilizationʺ in the economy refers to
A)the properties of government spending and taxation that cause the simple multiplier to be increased.
B)the discretionary fiscal policies that are automatically undertaken by the government when there is a recessionary gap.
C)the properties of government spending and taxation that cause the simple multiplier to be reduced.
D)the discretionary fiscal policies that are automatically undertaken by the government when there is an inflationary gap.
E)all discretionary fiscal policies.

Accepted Answer

Automatic fiscal stabilization refers to how government spending and taxation automatically adjust to economic changes without new legislative action, thereby dampening economic fluctuations. This typically reduces the impact of changes in the economy on the aggregate demand, which in turn affects the simple multiplier.

Question 2

Automatic fiscal stabilizers ________ the impact of demand or supply shocks on the economy since governmentʹs net tax revenues ________ during booms and ________ during recessions.
A)magnify; increase; decrease
B)magnify; decrease; increase
C)dampen; increase; decrease
D)dampen; decrease; increase
E)does not affect; are constant; are constant

Accepted Answer

Automatic fiscal stabilizers dampen the impact of economic fluctuations by increasing government's net tax revenues during booms (when incomes are higher and more taxes are collected) and decreasing them during recessions (when incomes are lower and less taxes are collected), thus providing a counter-cyclical effect.

Question 3

Consider a simple macro model with demand-determined output.Which of the following parameters will produce the largest fluctuations in real GDP from autonomous expenditure shocks?
A)MPC = 0.8,t = 0.2,m = 0.3
B)MPC = 0.7,t = 0.3,m = 0.2
C)MPC = 0.7,t = 0.1,m = 0.4
D)MPC = 0.9,t = 0.2,m = 0.4
E)MPC = 0.8,t = 0.1,m = 0.2

Accepted Answer

The answer of Consider a simple macro model with demand-determined...

Question 4

Suppose the government implements a permanent reduction in the net tax rate in an effort to increase real GDP.One disadvantage of this policy is that
A)the effect of economic shocks on government revenues becomes more volatile,while the economy becomes more stable.
B)further reductions in the net tax rate will be required to maintain the effectiveness of the tax rate as an automatic stabilizer.
C)private investment is crowded out,which may reduce the future growth rate of potential output.
D)the effect of the automatic stabilizer is reduced and the economy will be more unstable.
E)both C and D are correct.

Accepted Answer

A permanent reduction in the net tax rate may lead to increased government deficits which could increase interest rates and limit private investment. This crowding out effect may reduce the future growth rate of potential output. Additionally, by reducing the effectiveness of the automatic stabilizer, the economy may become more unstable in the face of economic shocks. Therefore, both choices C and D are correct.

Question 5

In the long run, aggregate demand is ________ for determining real GDP, and the paradox of thrift ________.
A)not important; applies
B)not important; does not apply
C)the only influence; applies
D)the most important influence; does not apply
E)stable and important; applies

Accepted Answer

In the long run, aggregate demand does not determine real GDP because the economy tends to adjust to its potential output through price and wage changes. The paradox of thrift, which suggests that increased saving can lead to a decrease in aggregate demand, thereby harming the economy, does not apply in the long run as the economy adjusts to its full employment output.

Question 6

Suppose the economy is in macroeconomic equilibrium with real GDP equal to Y*.If the government then implements an expansionary fiscal policy by increasing government purchases,what are the long -run effects on potential output?
A)The growth rate of potential output may be reduced due to the crowding out of private investment.
B)Potential output will adjust to the new higher level achieved with the expansionary fiscal policy.
C)Potential output will drop below its starting point because of the crowding out of investment.
D)The growth rate of potential output will rise due to the higher level of aggregate demand.
E)The level of potential output is fixed and will not be affected by fiscal policy.

Accepted Answer

A) Expansionary fiscal policy can lead to higher interest rates, which may crowd out private investment. This reduction in investment can slow the growth of the capital stock, potentially reducing the growth rate of potential output over time. Potential output is determined by factors like technology, labor, and capital, not by the level of aggregate demand.

Question 7

The ʺparadox of thriftʺ refers to the understandable tendency of people who are worried about their economic situation to ________ their saving, but in aggregate this behaviour causes a ________ recession.
A)decrease; more severe
B)decrease; less severe
C)increase; more severe
D)increase; less severe
E)increase; shorter

Accepted Answer

The "paradox of thrift" posits that while it may seem prudent for individuals to save more during economic downturns, if everyone does so simultaneously, the overall demand decreases. This reduction in spending can lead to a deeper recession, as businesses earn less and may cut jobs, further exacerbating the economic downturn.

Question 8

An important automatic fiscal stabilizer in Canada is
A)the exchange rate.
B)the marginal propensity to consume.
C)the marginal propensity to import.
D)the income-tax system.
E)government purchases of goods and services.

Accepted Answer

The income-tax system is an important automatic fiscal stabilizer in Canada. As the economy enters a downturn, individuals and businesses experience lower incomes, which results in lower tax revenues for the government. The income-tax system then automatically adjusts by lowering the tax burden on individuals and businesses, thereby reducing the negative impact on their purchasing power and stimulating economic activity. Similarly, during an economic upswing, tax revenues increase automatically, which allows the government to save for future economic downturns.

Question 9

The paradox of thrift does not exist in the long run because
A)not everyone increases saving in the long run.
B)aggregate supply has an impact on real GDP only in the short run.
C)everyone increases consumption in the long run.
D)changes in aggregate demand have no impact on real GDP in the long run.
E)potential output is determined by changes in the price level.

Accepted Answer

The paradox of thrift suggests that increased saving can lead to a decrease in aggregate demand, slowing the economy. However, in the long run, changes in aggregate demand do not affect real GDP because the economy adjusts to its potential output, which is determined by factors like technology, capital, and labor, rather than by the level of aggregate demand.

Question 10

Which of the following statements about fiscal policy is the best description of ʺfine tuningʺ?
A)The government continuously alters its spending and taxing plans to hold real GDP at potential.
B)The government cuts taxes to remove a large and persistent recessionary gap.
C)The government increases its spending to reduce an inflationary gap.
D)The government decreases tax rates to decrease an inflationary gap.
E)The government uses automatic stabilizers to reduce any output gaps.

Accepted Answer

"Fine tuning" refers to the continuous adjustments that the government makes to its spending and taxing plans in order to keep the economy at its potential output. This means that the government is constantly monitoring the economy and making small changes to its fiscal policy in order to keep inflation low, unemployment at a minimum, and economic growth steady. Choice A is the only statement that accurately describes this concept.

Question 11

Consider a simple macro model with demand-determined output.Which of the following parameters will produce the most stable real GDP in the face of autonomous expenditure shocks?
A)MPC = 0.8,t = 0.2,m = 0.3
B)MPC = 0.7,t = 0.3,m = 0.2
C)MPC = 0.7,t = 0.1,m = 0.4
D)MPC = 0.9,t = 0.2,m = 0.4
E)MPC = 0.8,t = 0.1,m = 0.2

Accepted Answer

In this scenario, the most stable real GDP would be achieved by having a lower MPC and a higher tax rate. This is because a lower MPC means that there is less sensitivity in consumption to changes in income, leading to smaller fluctuations in output. Additionally, a higher tax rate means that there is less disposable income available for spending, which further dampens the effects of autonomous expenditure shocks on output. Therefore, option C, with an MPC of 0.7, a tax rate of 0.1, and a marginal propensity to import (m) of 0.4, would be the most stable.

Question 12

Consider the simplest macro model with demand-determined output. Other things being equal, the ________the value of the simple multiplier, the ________ stable is real GDP in response to shocks to autonomous spending.
A)larger; more
B)larger; less
C)smaller; more
D)smaller; less
E)both B and C are correct

Accepted Answer

The simple multiplier amplifies changes in autonomous spending into larger changes in real GDP. A larger multiplier means that any shock to autonomous spending results in a larger change in GDP, making it less stable. Conversely, a smaller multiplier dampens the effect of changes in autonomous spending on GDP, making it more stable. Therefore, both B and C are correct.

Question 13

Suppose the government had made a decision to change fiscal policy,but it then took nine months to implement a tax reduction.This is an example of
A)a decision lag.
B)fine tuning.
C)gross tuning.
D)automatic fiscal stabilizers.
E)an execution lag.

Accepted Answer

An execution lag refers to the time it takes for policy changes to be implemented once a decision has been made. In this case, it took nine months for the tax reduction to be implemented, indicating an execution lag. The other options do not accurately describe the situation.

Question 14

An expansionary fiscal policy that takes the form of an increase in government purchases carries the possibility that private investment ________ and, as a result, the future growth rate of ________.
A)rises to an unsustainable level; real GDP is reduced
B)is crowded out; corporate tax revenue is reduced
C)increases; aggregate demand increases
D)increases; net exports increases
E)is crowded out; potential output is reduced

Accepted Answer

An expansionary fiscal policy, such as an increase in government purchases, can lead to higher interest rates, which may crowd out private investment. This reduction in investment can negatively affect the future growth rate of potential output by limiting the expansion of the economy's productive capacity.

Question 15

Net tax revenues that rise with national income act as an automatic stabilizer by ________ the marginal propensity to spend and thereby causing the simple multiplier to ________.
A)increasing; increase
B)increasing; decrease
C)decreasing; equal one
D)decreasing; decrease
E)decreasing; increase

Accepted Answer

Net tax revenues that rise with national income act as an automatic stabilizer by decreasing the marginal propensity to spend (because individuals have less disposable income to spend as taxes increase). This, in turn, causes the simple multiplier to decrease because the economy is less sensitive to changes in spending.

Question 16

Suppose the economy is experiencing a significant recessionary gap,but it has taken the government six months to determine that it will change fiscal policy.This is an example of
A)an execution lag.
B)fine tuning.
C)gross tuning.
D)a decision lag.
E)automatic fiscal stabilizers.

Accepted Answer

A decision lag occurs when it takes the government a significant amount of time to make a decision regarding fiscal policy. In this case, it took six months to determine that a change in fiscal policy was necessary to address the recessionary gap.

Question 17

In any decision about stimulating the economy with a fiscal expansion (increasing government purchases),the government must weigh the short-run benefits  of ________ against the long-run costs of ________.
A)a higher price level; unemployment
B)increased potential output; a higher price level
C)a higher price level; lower real GDP
D)increased real GDP; higher economic growth
E)increased economic activity; lower economic growth

Accepted Answer

The short-run benefits of fiscal expansion include increased economic activity, such as higher employment and output. However, the long-run costs often involve lower economic growth due to factors like increased debt, higher interest rates, and potential crowding out of private investment.

Question 18

Automatic fiscal stabilizers are most helpful in
A)making discretionary fiscal policy effective.
B)removing persistent output gaps.
C)promoting economic growth.
D)eliminating price fluctuations in the economy.
E)reducing the intensity of business cycles.

Accepted Answer

Automatic fiscal stabilizers, such as unemployment benefits and progressive income taxes, help to smooth out fluctuations in the business cycle by providing support to households during economic downturns. This reduces the severity of economic downturns and helps to stabilize overall economic activity.

Question 19

In the basic AD/AS macro model,the ʺparadox of thriftʺ is only a short-run phenomenon because
A)consumers exhibit cyclical consumption behaviour.
B)in the long run output is determined by potential output.
C)savings are transformed into expenditures in the long run.
D)the marginal propensity to consume is fixed in the long run.
E)consumers base their consumption expenditures only on their lifetime income.

Accepted Answer

In the long run, the paradox of thrift is resolved because the economy adjusts to potential output, which is determined by the economy's supply side factors such as technology, capital, and labor. In the short run, however, an increase in savings may lead to a decrease in aggregate demand, output, and employment, as consumers spend less and firms reduce production.

Question 20

Which of the following statements about fiscal policy is the best example of ʺgross tuningʺ?
A)The government continuously alters its spending and taxing plans to hold real GDP at potential.
B)The government cuts taxes to remove a large and persistent recessionary gap.
C)The government increases its spending to reduce an inflationary gap.
D)The government decreases tax rates to decrease an inflationary gap.
E)The government uses automatic stabilizers to reduce any output gaps.

Accepted Answer

Gross tuning refers to the use of fiscal policy to make significant adjustments to the economy, such as large tax cuts to combat a substantial recessionary gap. This contrasts with fine-tuning, which involves smaller, more frequent adjustments to stabilize the economy.

Quiz 24: From the Short Run to the Long Run: the Adjustment of Factor Prices

ʺAutomatic fiscal stabilizationʺ in the economy refers to

Automatic fiscal stabilizers the impact of demand or supply shocks on the economy since governmentʹs net tax revenues during booms and during recessions.

Consider a simple macro model with demand-determined output.Which of the following parameters will produce the largest fluctuations in real GDP from autonomous expenditure shocks?

Suppose the government implements a permanent reduction in the net tax rate in an effort to increase real GDP.One disadvantage of this policy is that

In the long run, aggregate demand is for determining real GDP, and the paradox of thrift .

Suppose the economy is in macroeconomic equilibrium with real GDP equal to Y*.If the government then implements an expansionary fiscal policy by increasing government purchases,what are the long -run effects on potential output?

The ʺparadox of thriftʺ refers to the understandable tendency of people who are worried about their economic situation to their saving, but in aggregate this behaviour causes a recession.

An important automatic fiscal stabilizer in Canada is

The paradox of thrift does not exist in the long run because

Which of the following statements about fiscal policy is the best description of ʺfine tuningʺ?

Consider a simple macro model with demand-determined output.Which of the following parameters will produce the most stable real GDP in the face of autonomous expenditure shocks?

Consider the simplest macro model with demand-determined output. Other things being equal, the the value of the simple multiplier, the stable is real GDP in response to shocks to autonomous spending.

Suppose the government had made a decision to change fiscal policy,but it then took nine months to implement a tax reduction.This is an example of

An expansionary fiscal policy that takes the form of an increase in government purchases carries the possibility that private investment and, as a result, the future growth rate of .

Net tax revenues that rise with national income act as an automatic stabilizer by the marginal propensity to spend and thereby causing the simple multiplier to .

Suppose the economy is experiencing a significant recessionary gap,but it has taken the government six months to determine that it will change fiscal policy.This is an example of

In any decision about stimulating the economy with a fiscal expansion (increasing government purchases) ,the government must weigh the short-run benefits of against the long-run costs of .

Automatic fiscal stabilizers are most helpful in

In the basic AD/AS macro model,the ʺparadox of thriftʺ is only a short-run phenomenon because

Which of the following statements about fiscal policy is the best example of ʺgross tuningʺ?