Question 1

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?

Accepted Answer

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

Question 2

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?

Accepted Answer

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

Question 3

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?

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 4

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

Accepted Answer

Temporary tax cuts are less likely to cause a significant increase in consumer spending and aggregate demand because consumers are aware that the cut will not be sustained, so they are less likely to change their spending habits in response to the temporary reduction in taxes. Thus, the effect of the 1992 tax cut was likely smaller than it would have been if the cut had been permanent.

Question 5

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?

Accepted Answer

The crowding-out effect tends to make the size of a shift in aggregate demand resulting from a tax cut smaller than it otherwise would be. This happens because a tax cut increases disposable income, leading to an increase in consumption and aggregate demand. However, if the increased demand leads to higher interest rates, investment spending may decrease due to increased borrowing costs, which can offset some or all of the initial increase in demand. The multiplier effect and accelerator effect both tend to amplify the size of a shift in aggregate demand resulting from a tax cut, so they are not the correct choice.

Question 6

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

Accepted Answer

The answer of Which of the following sequences best represents...

Question 7

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?

Accepted Answer

Both the multiplier effect (which would increase the change in aggregate demand) and the crowding-out effect (which would decrease the change in aggregate demand) would influence the overall effect of a $75 billion increase in government spending. Therefore, the change in aggregate demand would be different from $75 billion.

Question 8

As income rises

Accepted Answer

As income rises, people will have more money to spend and will demand more goods and services. This will increase the demand for money, causing the interest rate to rise. This is because people will be willing to pay a higher price (i.e. interest rate) to borrow money in order to purchase more goods and services. Therefore, the correct answer is A.

Question 9

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

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 10

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

Accepted Answer

An increase in government expenditures can lead to higher GDP and income, leading to an increase in demand for investment goods. This can activate the investment accelerator effect, where firms invest more due to increased demand for their goods and services. However, an increase in government spending can also lead to higher interest rates, crowding out private investment. In this case, the investment accelerator effect is still present, but it is decreased by the crowding-out effect. Therefore, choice B is the best answer as it identifies the investment accelerator but acknowledges the possibility of crowding out.

Question 11

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?

Accepted Answer

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

Question 12

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?

Accepted Answer

Given MPC = 0.9, we can use the formula for government spending multiplier and tax multiplier to calculate the shift in aggregate demand:

Government spending multiplier = 1 / (1 - MPC) = 1 / (1 - 0.9) = 10

Tax multiplier = MPC / (1 - MPC) = 0.9 / (1 - 0.9) = 9

a) If the government increases its expenditures by $30 billion, then the shift in aggregate demand will be:

$30 billion x 10 = $300 billion

b) If the government decreases taxes by $30 billion, then the shift in aggregate demand will be:

$30 billion x 9 = $270 billion

Therefore, the correct answer is C as it matches the calculated values.

Question 13

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?

Accepted Answer

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

Question 14

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

Accepted Answer

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

Question 15

Permanent tax cuts shift the AD curve

Accepted Answer

Permanent tax cuts provide a long-term increase in disposable income, leading to increased consumption and investment. This shifts the aggregate demand (AD) curve farther to the right than temporary tax cuts, which only provide a short-term boost to disposable income and therefore have a smaller impact on AD.

Question 16

A tax cut shifts the aggregate demand curve the farthest if

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 17

A tax increase has

Accepted Answer

The answer of A tax increase has
...

Question 18

A tax cut shifts aggregate demand

Accepted Answer

The answer of A tax cut shifts aggregate demand
...

Question 19

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

Accepted Answer

If households view a tax cut as temporary, they are less likely to change their spending and saving habits because they expect the tax cut to expire and their taxes to increase again. This means that the tax cut has less of an impact on aggregate demand compared to if households view it as permanent.

Question 20

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

Accepted Answer

The formula for calculating the change in aggregate demand is:
Change in aggregate demand = multiplier x change in government spending
Therefore, Change in aggregate demand = 6 x $60 billion = $360 billion. This means that option C is the correct answer.

Quiz 16: The Influence of Monetary and Fiscal Policy on Aggregate Demand