Question 1

Which of the following sequences best represents the crowding-out effect?
A)government purchases $\uparrow \Rightarrow$ GDP$\uparrow \Rightarrow$ supply of money $\darr\Rightarrow$ equilibrium interest rate $\uparrow \Rightarrow$ quantity of goods and services demanded $\darr$

B)government purchases $\darr\Rightarrow$ GDP $\darr\Rightarrow$ demand for money $\darr\Rightarrow$ equilibrium interest rate $\darr\Rightarrow$ quantity of goods and services demanded $\darr$

C)government purchases $\uparrow \Rightarrow$ GDP $\uparrow \Rightarrow$ demand for money $\uparrow \Rightarrow$ equilibrium interest rate $\uparrow \Rightarrow$ quantity of goods and services demanded $\darr$

D)taxes $\uparrow \Rightarrow$GDP $\darr\Rightarrow$ demand for money $\darr\Rightarrow$ equilibrium interest rate $\uparrow \Rightarrow$ quantity of goods and services demanded $\darr$

Accepted Answer

The crowding-out effect occurs when increased government spending raises GDP, leading to higher demand for money, which increases interest rates and reduces private investment, thus decreasing the quantity of goods and services demanded.

Question 2

If the multiplier is 6 and if there is no crowding-out effect, then a $60 billion increase in government expenditures causes aggregate demand to
A)increase by $250 billion.
B)increase by $333 billion.
C)increase by $360 billion.
D)None of the above are correct.

Accepted Answer

The formula for calculating the impact of a change in government expenditures on aggregate demand is:

ΔAD = multiplier x ΔG

where ΔAD is the change in aggregate demand, ΔG is the change in government expenditures, and the multiplier is the amount by which aggregate demand will ultimately shift in response to the initial change in spending.

Given that the multiplier is 6, and ΔG (the change in government expenditures) is $60 billion, we can calculate the change in aggregate demand as follows:

ΔAD = 6 x $60 billion = $360 billion

Therefore, a $60 billion increase in government expenditures with a multiplier of 6 would result in a $360 billion increase in aggregate demand.

Question 3

If households view a tax cut as temporary, then the tax cut
A)has no affect on aggregate demand.
B)has more of an affect on aggregate demand than if households view it as permanent.
C)has the same affect as when households view the cut as permanent.
D)has less of an affect on aggregate demand than if households view it as permanent.

Accepted Answer

If households view the tax cut as temporary, they are less likely to increase their spending because they anticipate the taxes will go back up soon. Thus, the tax cut has less of an impact on aggregate demand compared to if households viewed it as a permanent tax cut.

Question 4

Imagine that the government increases its spending by $75 billion. Which of the following by itself would tend to make the change in aggregate demand different from $75 billion?
A)both the multiplier effect and the crowding-out effect
B)the multiplier effect, but not the crowding-out effect
C)the crowding-out effect, but not the multiplier effect
D)neither the crowding out effect nor the multiplier effect

Accepted Answer

Both the multiplier effect and the crowding-out effect could influence the total change in aggregate demand. The multiplier effect suggests that the total change in spending could be greater than $75 billion because the initial spending could lead to subsequent rounds of spending as income and consumption increase. However, the crowding-out effect suggests that some of the initial spending may be offset by a decrease in private spending or investment due to higher interest rates caused by the increased government borrowing. Therefore, the total change in aggregate demand could be different from $75 billion depending on the strength of these two effects.

Question 5

As income rises
A)money demand rises, so the interest rate rises.
B)money demand rises, so the interest rate falls
C)money demand falls, so the interest rate rises.
D)money demand falls, so the interest rate falls.

Accepted Answer

As income rises, people tend to spend more, which increases the demand for money. This will lead to an increase in the interest rate to balance the increased demand for money with the limited supply available. Therefore, option A is the correct choice.

Question 6

Which of the following tends to make the size of a shift in aggregate demand resulting from a tax cut smaller than it otherwise would be?
A)the multiplier effect
B)the crowding-out effect
C)the accelerator effect
D)None of the above is correct.

Accepted Answer

The crowding-out effect tends to reduce the size of the shift in aggregate demand resulting from a tax cut. This occurs because the increased government borrowing associated with the tax cut may lead to higher interest rates and less private sector investment, offsetting some of the potential expansionary effects of the tax cut. The multiplier effect and accelerator effect both tend to amplify the size of shifts in aggregate demand, and thus do not fit the given question prompt.

Question 7

A significant example of a temporary tax cut was the one announced in 1992 by President George H. W. Bush. The effect of that tax cut on consumer spending and aggregate demand was
A)zero.
B)likely smaller than if the cut had been permanent.
C)likely about the same as if the cut had been permanent.
D)likely larger than if the cut had been permanent.

Accepted Answer

A temporary tax cut is unlikely to have a significant impact on consumer spending and aggregate demand because it does not create a permanent change in after-tax income. Consumers may save rather than spend the additional disposable income from a temporary tax cut, while businesses and investors may not invest as much due to uncertainty about the future. Therefore, the effect of a temporary tax cut is likely to be smaller than if the cut had been permanent.

Question 8

Suppose the MPC is 0.9. There are no crowding out or investment accelerator effects. If the government increases its expenditures by $30 billion, then by how much does aggregate demand shift to the right? If the government decreases taxes by $30 billion, then by how far does aggregate demand shift to the right?
A)$283 billion and $254.7 billion
B)$283 billion and $283 billion
C)$300 billion and $270 billion
D)$300 billion and $300 billion

Accepted Answer

- When the government increases its expenditures by $30 billion, the shift in aggregate demand is calculated as:
     AD shift = MPC * ΔG  
     where MPC is the marginal propensity to consume, and ΔG is the change in government expenditures.
     AD shift = 0.9 * $30 billion = $27 billion
     However, since there are no crowding out or investment accelerator effects, the multiplier is equal to one.
     Therefore, the total shift in aggregate demand is:
     AD shift = ΔG * multiplier = $30 billion * 1 = $30 billion
- When the government decreases taxes by $30 billion, the shift in aggregate demand is calculated as:
     AD shift = MPC * ΔT  
     where MPC is the marginal propensity to consume, and ΔT is the change in taxes.
     AD shift = 0.9 * -$30 billion = -$27 billion
     However, since there are no crowding out or investment accelerator effects, the multiplier is equal to one.
     Therefore, the total shift in aggregate demand is:
     AD shift = ΔT * multiplier = -$30 billion * 1 = -$30 billion
- Thus, aggregate demand shifts to the right by $300 billion when the government increases its expenditures by $30 billion and shifts to the right by $270 billion when the government decreases taxes by $30 billion. Hence, the correct option is C.

Question 9

Initially, the economy is in long-run equilibrium. Aggregate demand then shifts leftward by $50 billion. The government wants to increase its 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 0.8, then by how much do government purchases have to increase in order to offset the $50 billion leftward shift?
A)by $5 billion
B)by $10 billion
C)by $20 billion
D)by $50 billion

Accepted Answer

The multiplier effect is given by:

1/(1-MPC) = 1/(1-0.8) = 5

Therefore, to offset the leftward shift of $50 billion, government purchases must increase by:

50/5 = 10

However, due to the crowding-out effect, the actual increase in real GDP will be smaller than $10 billion, as some of the increase in government spending will be offset by a decrease in private investment. If the crowding-out effect is always half as strong as the multiplier effect, then the actual increase in real GDP will be:

10 - 0.5(10) = 10 - 5 = $5 billion

Therefore, the government must increase its purchases by $20 billion to offset the leftward shift, but only $5 billion of that increase will be realized in terms of actual GDP growth.

Question 10

A tax cut shifts the aggregate demand curve the farthest if
A)the MPC is large and if the tax cut is permanent.
B)the MPC is large and if the tax cut is temporary.
C)the MPC is small and if the tax cut is permanent.
D)the MPC is small and if the tax cut is temporary.

Accepted Answer

A tax cut shifts the aggregate demand curve the farthest if the marginal propensity to consume (MPC) is large and the tax cut is perceived as permanent. A large MPC means consumers are likely to spend a significant portion of any extra income they receive, and a permanent tax cut is more likely to encourage spending rather than saving, as people expect their higher disposable income to last.

Question 11

A tax increase has
A)a multiplier effect but not a crowding out effect
B)a crowding out effect but not a multiplier effect
C)both a crowding out and multiplier effect
D)neither a multiplier or crowding out effect

Accepted Answer

The answer of A tax increase has
A)a multiplier effect but...

Question 12

Initially, the economy is in long-run equilibrium. The aggregate demand curve then shifts $80 billion to the left. The government wants to change spending to offset this decrease in demand. The MPC is 0.75. Suppose the effect on aggregate demand of a tax change is 3/4 as strong as the effect of a change in government expenditure. There is no crowding out and no accelerator effect. What should the government do if it wants to offset the decrease in real GDP?
A)Raise both taxes and expenditures by $80 billion dollars.
B)Raise both taxes and expenditures by $10 billion dollars.
C)Reduce both taxes and expenditures by $80 billion dollars.
D)Reduce both taxes and expenditures by $10 billion dollars.

Accepted Answer

The answer of Initially, the economy is in long-run equilibrium....

Question 13

If a $1,000 increase in income leads to a $750 increase in consumption expenditures, then the marginal propensity to consume is
A)0.75 and the multiplier is 1 1/3.
B)0.75 and the multiplier is 4.
C)0.25 and the multiplier is 1 1/3.
D)0.25 and the multiplier is 4.

Accepted Answer

The answer of If a $1,000 increase in income leads...

Question 14

An aide to a U.S. Congressman computes the effect on aggregate demand of a $20 billion tax cut. The actual increase in aggregate demand is less than the aide expected. Which of the following errors in the aide's computation would be consistent with an overestimation of the impact on aggregate demand?
A)The actual MPC was larger than the MPC the aide used to compute the multiplier.
B)The aide thought the tax cut would be permanent, but the actual tax cut was temporary.
C)The increase in income shifted money demand less than the aide had anticipated.
D)The increase in income resulted in investment rising more than the aide had anticipated.

Accepted Answer

The answer of An aide to a U.S. Congressman computes...

Question 15

A tax cut shifts aggregate demand
A)by more than the amount of the tax cut.
B)by the same amount as the tax cut.
C)by less than the tax cut.
D)None of the above is necessarily correct.

Accepted Answer

The answer of A tax cut shifts aggregate demand
A)by more...

Question 16

Suppose the MPC is 0.60. Assume there are no crowding out or investment accelerator effects. If the government increases expenditures by $200 billion, then by how much does aggregate demand shift to the right? If the government decreases taxes by $200 billion, then by how much does aggregate demand shift to the right?
A)$300 billion and $180 billion
B)$300 billion and $300 billion
C)$500 billion and $300 billion
D)$500 billion and $500 billion

Accepted Answer

The answer of Suppose the MPC is 0.60. Assume there...

Question 17

Permanent tax cuts shift the AD curve
A)farther to the right than do temporary tax cuts.
B)not as far to the right as do temporary tax cuts.
C)farther to the left than do temporary tax cuts.
D)not as far to the left as do temporary tax cuts.

Accepted Answer

Permanent tax cuts provide a long-term boost to consumer and business confidence which leads to increased spending and investment. This shift in the AD curve is greater than that of temporary tax cuts which only provide a short-term stimulus.

Question 18

Initially, the economy is in long-run equilibrium. The aggregate demand curve then shifts $40 billion to the left. The government wants to change its spending to offset this decrease in demand. The MPC is 0.60. Suppose the effect on aggregate demand from a change in taxes is 3/5 the size of the change from government expenditures. There is no crowding out and no accelerator effect. What should the government do if it wants to offset the decrease in real GDP?
A)Raise both taxes and expenditures by $40 billion dollars.
B)Raise both taxes and expenditures by $40 billion dollars
C)Reduce both taxes and expenditures by $10 billion dollars.
D)Reduce both taxes and expenditures by $10 billion dollars

Accepted Answer

The government should raise both taxes and expenditures by $40 billion to offset the decrease in real GDP. This is because the MPC is 0.60, so a $40 billion decrease in aggregate demand will lead to a $66.67 billion decrease in real GDP. To offset this, the government needs to increase aggregate demand by $66.67 billion. Raising both taxes and expenditures by $40 billion will do this, as the increase in government spending will increase aggregate demand by $40 billion, and the decrease in taxes will increase aggregate demand by $26.67 billion (since the effect on aggregate demand from a change in taxes is 3/5 the size of the change from government expenditures).

Question 19

When the government reduces taxes, which of the following decreases?
A)consumption
B)take-home pay
C)household saving
D)None of the above is correct.

Accepted Answer

When the government reduces taxes, people have more take-home pay and disposable income, which can lead to an increase in consumption and household saving. Therefore, A, B, and C are not correct answers.

Question 20

When there is an increase in government expenditures, which of the following raises investment spending?
A)the investment accelerator and crowding out
B)the investment accelerator but not crowding out
C)crowding out but not the investment accelerator
D)neither the investment accelerator or crowding out

Accepted Answer

When there is an increase in government expenditures, it can lead to an increase in aggregate demand and therefore an increase in output and income. This increase in income can lead to an increase in investment spending through the investment accelerator mechanism, where firms increase investment in response to an increase in demand for their products. However, when government expenditures increase, it can also lead to crowding out of private investment, where higher government borrowing leads to higher interest rates and reduced private investment. Therefore, both the investment accelerator and crowding out mechanisms can occur, but the investment accelerator will tend to raise investment spending while crowding out will tend to reduce it. Hence, option B is correct.

Quiz 21: The Influence of Monetary and Fiscal Policy on Aggregate Demand

Which of the following sequences best represents the crowding-out effect?

If the multiplier is 6 and if there is no crowding-out effect, then a $60 billion increase in government expenditures causes aggregate demand to

If households view a tax cut as temporary, then the tax cut

Imagine that the government increases its spending by $75 billion. Which of the following by itself would tend to make the change in aggregate demand different from $75 billion?

As income rises

Which of the following tends to make the size of a shift in aggregate demand resulting from a tax cut smaller than it otherwise would be?

A significant example of a temporary tax cut was the one announced in 1992 by President George H. W. Bush. The effect of that tax cut on consumer spending and aggregate demand was

A tax cut shifts the aggregate demand curve the farthest if

A tax increase has

If a $1,000 increase in income leads to a $750 increase in consumption expenditures, then the marginal propensity to consume is

A tax cut shifts aggregate demand

Permanent tax cuts shift the AD curve

When the government reduces taxes, which of the following decreases?

When there is an increase in government expenditures, which of the following raises investment spending?