Question 1

Fiscal policies that encourage investment in human capital and development and transfers of new technology may be successful in allowing the economy to expand without generating inflationary pressures.

Accepted Answer

By investing in human capital and development and transferring new technology, the economy becomes more efficient and can produce more goods and services without necessarily increasing the price level, which means there is no inflationary pressure.

Question 2

If the government borrows from the _____, the quantity of _____ will rise.

Accepted Answer

When the government borrows from the public, it issues bonds, increasing the quantity of publicly held bonds.

Question 3

Economists in favor of the functional finance approach to balancing the federal budget believe that the first priority of lawmakers is to keep the economy at full employment with stable prices, not to balance the federal budget.

Accepted Answer

Functional finance approach prioritizes maintaining full employment with stable prices as the key goal, while balancing the federal budget is not the primary objective.

Question 4

Automatic stabilizers are MOST associated with the _____ balanced budget.

Accepted Answer

Automatic stabilizers are mechanisms within the economy that help to automatically stabilize economic output and employment levels over the business cycle. They work by increasing government spending and reducing taxes during a recession, and decreasing government spending and increasing taxes during an expansion. These changes happen automatically without any additional policy action needed from the government. Therefore, automatic stabilizers are most associated with a cyclically balanced budget, where the government's budget adjusts according to the state of the economy.

Question 5

The income tax is a powerful stabilizer because of its progressivity.

Accepted Answer

The income tax is a progressive tax, meaning that it takes a larger percentage of income from high-income earners than low-income earners. This helps to reduce income inequality and stabilize the economy, as those who can afford to pay more in taxes do so, while those who are struggling financially are not burdened as heavily. This progressivity makes the income tax a powerful stabilizer.

Question 6

Which type of fiscal policy involves reducing government spending, reducing transfer payments, or raising taxes to decrease aggregate demand?

Accepted Answer

Contractionary fiscal policy involves reducing government spending, reducing transfer payments, or raising taxes to decrease aggregate demand.

Question 7

According to the Laffer curve, what tax rate will maximize tax revenue?

Accepted Answer

According to the Laffer curve, there is a point beyond which increasing tax rates actually reduces tax revenue because it discourages work and investment. Conversely, reducing tax rates beyond a certain point can actually increase tax revenue by spurring economic growth. Therefore, the optimal tax rate that maximizes revenue is somewhere between zero and 100%, but not necessarily 50%.

Question 8

If the federal government were required to balance its budget annually

Accepted Answer

If the federal government were required to balance its budget annually, a recession would lead to either higher taxes or reduced spending in order to maintain the balanced budget. This would limit the ability of the government to use Keynesian aggregate demand policies in times of economic downturns. In contrast, during economic upturns, the government could reduce taxes or increase spending to maintain the balanced budget. Therefore, the federal budget would not act as an automatic stabilizer.

Question 9

Which statement(s) is/are TRUE? I. Changes in tax rates impact only aggregate demand.
II) According to the Laffer curve, if the tax rate is above 50%, lowering the tax rate will always raise tax revenue.
III) A repeal of existing investment tax credits will cause aggregate supply to shift to the left.

Accepted Answer

I is false, as changes in tax rates can also impact aggregate supply by affecting the incentives for work and investment. 
II is false, as the Laffer curve only suggests that there is a point where lowering tax rates can increase tax revenue, but it does not mean that this always happens at a tax rate above 50%. 
III is true, as a repeal of investment tax credits would reduce the incentives for businesses to invest, leading to a leftward shift in aggregate supply.

Question 10

One theory associated with supply-side economics is that

Accepted Answer

Supply-side economists believe that reducing marginal income tax rates would give individuals and businesses a greater incentive to work, invest, and take risks, ultimately leading to economic growth. This theory is commonly referred to as the "Laffer Curve," named after economist Arthur Laffer, and suggests that cutting taxes could actually increase total tax revenue by promoting economic activity.

Question 11

Mandatory spending comprises nearly _____ of the federal budget.

Accepted Answer

According to the latest data from the Congressional Budget Office, mandatory spending (primarily consisting of Social Security, Medicare, and Medicaid) makes up around 70% of the federal budget, leaving discretionary spending (defense, education, transportation, etc.) to make up the remaining 30%. Therefore, option D is the best choice.

Question 12

As market interest rates rise, the cost of the public debt

Accepted Answer

When market interest rates rise, the cost of the public debt also rises, because the government must pay higher interest rates to keep attracting investors to buy its bonds. This means that the government will have to allocate more of its budget to make interest payments, which could lead to higher taxes, reduced spending on other programs, or increased borrowing to cover the additional costs. Choice A is incorrect, as interest rates on some types of government debt may be fixed, but not all of it. Choice B is also incorrect, as safer financial assets may not necessarily offer higher returns than Treasury bonds, so investors may still demand higher interest rates to invest in government debt. Choice D is incorrect because Congress does not need to vote to increase interest payments, as these are usually set by market forces.

Question 13

Problems can begin to increase when countries with deficits that are a high percentage of their GDP also

Accepted Answer

Countries with high deficits as a percentage of their GDP are already overspending relative to their income. If they also have high debt-to-GDP ratios, it means the amount they owe is very high compared to their income, which can lead to concerns about their ability to pay off their debt. This can lead to increased borrowing costs and can make it even harder for the country to balance its budget.

Question 14

The advantage of automatic stabilizers over discretionary fiscal policy is that automatic stabilizers

Accepted Answer

Automatic stabilizers do not require overt action by policymakers because they are built into the tax and transfer systems, and are activated automatically as economic conditions change. Discretionary fiscal policy, on the other hand, requires active decision making and action by policymakers. This makes automatic stabilizers more effective in responding quickly to economic fluctuations.

Question 15

The developed nation with the highest debt-to-GDP ratio in 2018 was

Accepted Answer

According to data from the International Monetary Fund, Japan had a debt-to-GDP ratio of 237.6% in 2018, which was the highest among developed nations.

Question 16

The U.S. public debt fell during the _____ and rose during the _____.

Accepted Answer

The U.S. public debt fell during the 1950s due to post-World War II economic growth and fiscal policies, while it rose during the 2010s due to increased government spending and economic challenges.

Question 17

_____ government spending, _____ transfer payments, and _____ taxes all increase aggregate demand.

Accepted Answer

- Increasing government spending will increase aggregate demand as the government is directly injecting more money into the economy.
- Increasing transfer payments (such as unemployment benefits or social security) will also increase aggregate demand as individuals will have more disposable income to spend.
- Decreasing taxes will lead to an increase in consumer disposable income, which will increase consumption and aggregate demand.

Question 18

The Laffer curve demonstrates that

Accepted Answer

The Laffer curve shows that lower tax rates can lead to increased tax revenues up to a certain point, after which further tax cuts would reduce revenue. This means that policymakers cannot always increase tax revenues by raising tax rates and that higher tax rates may not necessarily lead to higher tax revenues.

Question 19

Under a cyclically balanced budget, a government should raise taxes when the economy is growing and reduce taxes when GDP is declining.

Accepted Answer

A cyclically balanced budget means that the government adjusts its spending and taxation policies based on the state of the economy. When the economy is growing, the government should increase taxes to prevent inflation and reduce borrowing. On the other hand, when the GDP is declining, the government should reduce taxes to encourage spending and boost economic activity. This approach ensures that the government maintains a stable budget over the business cycle.

Question 20

Automatic stabilizers are initiated by acts of Congress.

Accepted Answer

Automatic stabilizers are built into the economy's structure and function automatically without the need for new legislation or any discretionary action. They include programs like unemployment insurance and progressive income taxes, which automatically adjust to economic conditions and thus help stabilize the economy.

Quiz 10: Fiscal Policy and Debt