Question 1

If the government increases spending and there is a complete direct expenditure offset, then

Accepted Answer

If there is a complete direct expenditure offset, it means that private spending decreases by the same amount as government spending increases. Therefore, there is no net change in total spending in the economy, and aggregate demand (which represents total spending) will not change. Real GDP, which represents the total output of the economy, is directly affected by changes in aggregate demand, so it will also not change in this scenario. The price level is not affected by changes in government spending or private spending, so it will not drop. Finally, the government spending multiplier (which represents the amount by which GDP changes in response to a change in government spending) will be zero in this scenario, since there is no net change in GDP.

Question 2

The government wants to increase its spending to stimulate the economy. Taking into account direct expenditure offset effects, what is its best spending option?

Accepted Answer

The answer of The government wants to increase its spending...

Question 3

If the government began providing free textbooks to college students who would otherwise have bought their books from the private sector, the government's action would result in

Accepted Answer

Providing free textbooks to college students would result in a direct expenditure offset, as the government would be spending money on these textbooks instead of individual students. This could potentially lead to a redistribution of income and affect the private sector textbook market, but it would not directly impact real GDP or create a Ricardian dilemma.

Question 4

The Laffer curve shows a relationship between

Accepted Answer

The Laffer curve depicts the relationship between tax rates and tax revenue. It shows that as tax rates increase beyond a certain point, the incentive to work, invest, and innovate decreases, which ultimately leads to a decline in tax revenue. This curve is often used to argue for lower tax rates to boost economic growth and revenue.

Question 5

Supply-side economists argue that

Accepted Answer

Supply-side economists believe that lowering tax rates can incentivize individuals and businesses to work and invest more, leading to economic growth and potentially higher tax revenues despite lower tax rates. On the other hand, higher tax rates can discourage work and investment, leading to lower tax revenues even if the tax rates are higher. This is also known as the Laffer curve.

Question 6

By definition, a direct expenditure offset will occur whenever

Accepted Answer

A direct expenditure offset occurs when the government increases spending in an area that competes with the private sector, which can lead to a decrease in private investment, job creation, and economic growth. This is because the government's increased spending may crowd out private investment by increasing demand for resources and driving up prices. As a result, businesses may become less willing to invest in new projects and hire additional workers, which can offset the intended benefits of the government's spending.

Question 7

The tendency for expansionary fiscal policy to cause a reduction in planned real investment spending by the private sector is called

Accepted Answer

The crowding-out effect occurs when increased government spending, financed by borrowing, raises interest rates, which in turn reduces investment spending by businesses and individuals, leading to a decrease in private sector investment. This happens because the demand for loanable funds increases, leading to higher interest rates, which makes investment more expensive for firms, leading them to reduce investment spending.

Question 8

According to supply-side economists, lower marginal tax rates will not necessarily lead to lower tax revenues because

Accepted Answer

Lower marginal tax rates can lead to a higher output level, which can result in a growing tax base. When the tax base grows, even lower marginal tax rates can generate the same or higher amount of tax revenues. This is why supply-side economists argue that lower tax rates can stimulate economic growth and generate higher tax revenue over time.

Question 9

What does research tell us about the impact of Ricardian equivalence effects on the economy?

Accepted Answer

Research suggests that Ricardian equivalence effects may exist, but their sizes are unclear. Some studies have found very small impacts on both aggregate demand and supply, while others have found no evidence of any impact.

Question 10

According to supply-side economics, changes in marginal tax rates will have which of the following effects?

Accepted Answer

Supply-side economics holds that lower marginal tax rates lead to increased economic growth by incentivizing work, saving, and investment, all of which contribute to increased supply of goods and services in the market. Therefore, changes in marginal tax rates will affect all three factors, leading to changes in incentives to work, save, and invest.

Question 11

Supply-side economics focuses on tax cuts to stimulate

Accepted Answer

Supply-side economics focuses on stimulating aggregate supply by increasing production through tax cuts that incentivize businesses to invest and expand their operations. This leads to an increase in output, employment, and economic growth. It differs from demand-side economics, which focuses on increasing aggregate demand through government spending or household consumption.

Question 12

If the government increases its spending but does NOT raise taxes

Accepted Answer

When the government increases its spending without raising taxes, it typically needs to borrow funds to cover the additional expenditures. This is because the government's budget must be financed either through taxes, borrowing, or printing money. In this scenario, since taxes are not raised, borrowing is the implied method to finance the increased spending.

Question 13

If the government increases spending while holding taxes constant, we expect

Accepted Answer

When the government increases spending while holding taxes constant, it typically finances this additional spending by borrowing more. This increased demand for loanable funds tends to push interest rates up, as there is now more competition for those funds. Higher interest rates can make borrowing more expensive for businesses and consumers, potentially affecting investment and spending decisions.

Question 14

The Ricardian equivalence theorem states that

Accepted Answer

The Ricardian equivalence theorem suggests that individuals anticipate the future tax obligations resulting from a current increase in government borrowing to finance a tax cut, and therefore adjust their behavior in anticipation of future taxes. This means that the increase in government borrowing has no effect on aggregate demand, as the increase in consumer spending resulting from the tax cut is offset by an increase in savings to pay for future taxes.

Question 15

The concept that increased government spending will lead to lower investment and consumer spending is referred to as the

Accepted Answer

The concept of increased government spending leading to lower investment and consumer spending is referred to as the crowding-out effect. This is because government borrowing tends to increase interest rates, making borrowing more expensive for businesses and individuals. As a result, they may reduce their spending and investment activities. The other options are not relevant to this concept.

Question 16

One part of the supply-side argument is that

Accepted Answer

The supply-side argument suggests that lower marginal tax rates can stimulate economic growth and lead to an increase in total tax revenues. This is based on the idea that lower taxes can provide greater incentives for individuals and businesses to work, save, and invest, which in turn can lead to more output, employment, and income. However, this argument is controversial and has been subject to debate among economists and policymakers.

Question 17

The supporters of a proposal to increase marginal taxes on those earning over $250,000 a year say this change would generate $100 million in new tax revenues. A supply-side economist would argue that the actual revenue raised will be

Accepted Answer

According to supply-side economists, increasing taxes on high income earners would discourage them from working as hard because they would take home less money after taxes. This reduction in work effort would result in less economic growth, job creation, and tax revenue than expected, so the revenue raised would likely be less than the $100 million predicted by the supporters of the proposal.

Question 18

The crowding-out effect is

Accepted Answer

The crowding-out effect occurs when the government increases its spending, or reduces taxes, stimulating economic activity, but then reduces private sector activity due to a decrease in private investment or consumption as interest rates rise. This happens because the increase in government spending creates more demand for credit, which drives up interest rates, making it more expensive for private businesses and individuals to borrow, thereby discouraging investment and consumption. Therefore, expansionary fiscal policy will cause a decrease in planned investment or planned consumption in the private sector due to the crowding-out effect.

Question 19

At tax rates higher than the tax rate that maximizes tax revenues along a Laffer curve

Accepted Answer

The Laffer curve illustrates the relationship between tax rates and tax revenue, suggesting that there is an optimal tax rate that maximizes revenue. At tax rates higher than this optimal point, reducing tax rates can actually increase tax revenues by encouraging more economic activity and thus expanding the tax base.

Question 20

When supply-side policy is successful in raising equilibrium real Gross Domestic Product (GDP), the reason is that the policy generates

Accepted Answer

Supply-side policy aims to increase the potential output of the economy by increasing productivity, improving infrastructure, and encouraging investment. This leads to an increase in aggregate supply, which can shift the production possibilities frontier outward and increase the equilibrium real GDP. Therefore, the correct answer is B - an increase in aggregate supply. The other choices are incorrect as they do not describe the mechanism by which supply-side policy works.

Quiz 13: Fiscal Policy