Question 1

An increase or decrease in taxes will have a multiplier effect on equilibrium GDP on the demand side.

Accepted Answer

Changes in taxes will affect consumer spending and investment, which in turn will affect aggregate demand and ultimately the equilibrium GDP. This is known as the multiplier effect.

Question 2

Taxes, transfer payments, and government purchases are the components of automatic stabilizers.

Accepted Answer

Automatic stabilizers refer to taxes and transfer payments, but not government purchases. Automatic stabilizers automatically adjust to economic changes without additional legislative action, helping to moderate economic fluctuations.

Question 3

When taxes are decreased, disposable income increases even though GDP is unchanged.

Accepted Answer

When taxes are decreased, individuals and businesses have more money left over after paying taxes. This increases disposable income, which is the amount of money available for spending and saving. However, since GDP is calculated as the total value of all goods and services produced in an economy, reducing taxes does not directly change the level of GDP.

Question 4

Fiscal policy is the use of taxes and spending by the government to affect aggregate demand.

Accepted Answer

Fiscal policy refers to the use of government spending and taxation to influence the overall level of economic activity or aggregate demand.

Question 5

A tax reduction shifts the consumption schedule downward.

Accepted Answer

A tax reduction typically increases disposable income, leading to an upward shift in the consumption schedule as consumers have more income to spend.

Question 6

Government purchases and income taxes have the same effect on the multiplier.

Accepted Answer

Government purchases directly affect aggregate demand and have a more immediate impact on the multiplier effect, whereas income taxes indirectly affect aggregate demand through changes in disposable income, leading to a different impact on the multiplier.

Question 7

The addition of imports reduces the value of the multiplier.

Accepted Answer

When a country imports goods, it means that the money spent on those imports is leaving the economy, which decreases the total amount of money circulating within the economy. As a result, this reduces the multiplier effect of any initial spending in the economy, thereby reducing the overall impact of any fiscal or monetary policies.

Question 8

When the government taxes and spends, each activity affects GDP in the same proportion.

Accepted Answer

Taxation and spending by the government can have different effects on GDP. Taxes can lead to a decrease in consumption and investment, reducing GDP. However, government spending can increase GDP if it leads to increased demand and production. The extent of these effects can vary depending on the specific circumstances and policies.

Question 9

If increases in government spending lead to inflation, the value of the multiplier is reduced.

Accepted Answer

This is because higher government spending increases aggregate demand, which leads to an increase in prices. As a result, the value of the multiplier decreases because each additional dollar of government spending generates less additional output due to inflationary pressures.

Question 10

If the MPC in the United States was low, it would increase the value of the multiplier.

Accepted Answer

The multiplier is inversely related to the marginal propensity to save (MPS), which is the complement of the marginal propensity to consume (MPC). Therefore, a lower MPC (meaning a higher MPS) would actually decrease the value of the multiplier.

Question 11

If the MPC in the United States was high, it would increase the value of the multiplier.

Accepted Answer

A higher MPC (marginal propensity to consume) means that individuals are more likely to spend a larger portion of any additional income they receive. This means that an initial increase in spending or investment would have a larger subsequent effect on total economic activity, i.e. the multiplier effect. Therefore, a higher MPC would result in a higher value for the multiplier.

Question 12

Automatic stabilizers are features of the economy that reduces its sensitivity to shocks, such as sharp increases or decreases in spending.

Accepted Answer

Automatic stabilizers are government policies and programs that automatically adjust to offset economic fluctuations, without a specific action or intervention by policymakers. They are meant to reduce the impact of economic shocks and can include things like unemployment insurance, progressive income taxes, and welfare programs.

Question 13

Any tax reduction shifts the consumption schedule upward.

Accepted Answer

Any tax reduction will leave people with more disposable income, therefore increasing their consumption at all levels of income, shifting the consumption schedule upward.

Question 14

A one-dollar tax reduction has the same effect as a one-dollar increase in government purchases.

Accepted Answer

A one-dollar tax reduction increases disposable income, leading to increased consumption based on the marginal propensity to consume, whereas a one-dollar increase in government purchases directly increases aggregate demand by the full dollar.

Question 15

Taxes constitute the difference between GDP and disposable income.

Accepted Answer

Taxes reduce the amount of income that individuals have available to spend or save, thus the difference between the Gross Domestic Product (GDP) and disposable income largely reflects the amount of taxes collected by the government.

Question 16

Inflationary gaps can be cured by either cutting government expenditures or raising taxes.

Accepted Answer

When there is an inflationary gap, it means that the aggregate demand is higher than the aggregate supply. To cure this, the government can either reduce its own expenditures to decrease the overall demand or increase taxes to decrease the disposable income of consumers and, thus, reduce their demand for goods and services.

Question 17

The personal income tax varies as GDP changes.

Accepted Answer

Personal income tax is typically based on a percentage of a person's income. As GDP increases, so does the total income of individuals, which leads to an increase in tax revenue collected from personal income tax. Conversely, as GDP decreases, so does the total income of individuals and the amount of tax revenue collected from personal income tax decreases.

Question 18

Government purchases have the same multiplier effect as business investment spending.

Accepted Answer

This is true because both government purchases and business investment spending inject money into the economy, creating a ripple effect as that money circulates through it. Therefore, the multiplier effect is similar for both types of spending.

Question 19

Transfer payments represent income that is not earned but received by individuals.

Accepted Answer

Transfer payments are payments made to individuals by the government or other organizations without the individuals having to earn the payments through work or investment. Examples include social security, welfare, and grants.

Question 20

Most tax payments increase as GDP increases.

Accepted Answer

This is because tax systems are usually structured to collect more revenue as income and economic activity increases. As such, the government can collect more revenue while people and businesses still have more money to spend and invest.

Quiz 27: Managing Aggregate Demand: Fiscal Policy