Question 1

The multiplier effect of fiscal policy means that a change in government spending:

Accepted Answer

The multiplier effect of fiscal policy refers to the phenomenon where an initial change in government spending results in a larger total increase in national income and output. This occurs because the initial spending generates income for those who receive it, who then spend a portion of this income, further increasing aggregate demand and income in a virtuous cycle.

Question 2

(Figure: Fiscal Stimulus) The figure shows fiscal stimulus with the multiplier effect. Increased government spending directly boosts aggregate demand, shifting the aggregate demand curve. The extra income earned producing government services then leads to _____ consumption, which further increases aggregate demand when the multiplier is _____.

Accepted Answer

The answer of (Figure: Fiscal Stimulus) The figure shows fiscal...

Question 3

A leakage occurs in an economy when:

Accepted Answer

Leakages in an economy refer to the withdrawal of potential spending from the economy's circular flow of income and expenditure. Savings, taxes, and imports are classic examples of leakages because they represent income that is not spent on domestically produced goods and services, thereby reducing the overall level of economic activity.

Question 4

Which of the following provides an example of "crowding out"?

Accepted Answer

Crowding out occurs when increased government spending leads to higher borrowing by the government, which in turn raises interest rates and reduces the amount of capital available for private investment. Option A accurately describes this process by stating that increases in government purchases and subsequent borrowing decrease the funds available for private investors in the loanable funds markets.

Question 5

When used in connection with fiscal policy, the term "crowding out" refers to:

Accepted Answer

Crowding out refers to a situation where increased government spending leads to a reduction in private sector spending, which can happen because the government borrowing to finance its spending leads to higher interest rates, making it more expensive for the private sector to borrow and invest.

Question 6

Which of the following terms is used to describe an expansionary fiscal policy that has little impact on an economy because the necessary increase in government borrowing leads to a decrease in investment spending?

Accepted Answer

Crowding out occurs when increased government borrowing to finance its budget deficit reduces investment spending in the economy because it leads to higher interest rates.

Question 7

According to the permanent income theory, households spend money based on:

Accepted Answer

The permanent income theory suggests that households base their consumption spending on their expected lifetime income rather than their current income. This theory implies that temporary changes in income do not have a large effect on consumption because households consider their long-term financial outlook when making spending decisions.

Question 8

Which of the following provides an example of decisions that are consistent with the permanent income theory?

Accepted Answer

The permanent income theory suggests that individuals base their consumption on their expected long-term average income rather than their current income. Choice C, where households save most of a one-year tax rebate, aligns with this theory because it implies that households do not view the rebate as a permanent increase in income and therefore choose to save rather than spend the additional funds.

Question 9

The idea that households spend each year based on their expected long-run income rather than their current income is known as the:

Accepted Answer

The permanent income theory, proposed by Milton Friedman, suggests that households base their consumption decisions on their long-term income expectations rather than their current income, aiming to smooth consumption over time.

Question 10

Which one of the following is NOT a reason that fiscal policy may fail to obtain its desired outcome?

Accepted Answer

The multiplier effect is actually a mechanism through which fiscal policy can be effective, not a reason for its failure. It describes how an initial increase in spending leads to further increases in income and consumption, amplifying the initial impact of the fiscal policy.

Question 11

A monetary offset of an expansionary fiscal policy occurs when:

Accepted Answer

Contractionary monetary policy implemented concurrently with an expansionary fiscal policy can offset the effects of the fiscal policy by increasing interest rates, which can dampen investment and spending, counteracting the fiscal policy's intent to stimulate the economy.

Question 12

During 2013, the U.S. government used contractionary fiscal policy to reduce its budget deficit, and the Federal Reserve expanded the money supply. Economists refer to this type of policy combination as a:

Accepted Answer

A monetary offset occurs when the central bank (in this case, the Federal Reserve) uses monetary policy to counteract the effects of fiscal policy. In this scenario, the contractionary fiscal policy aimed to reduce the budget deficit, while the expansion of the money supply by the Federal Reserve was a form of expansionary monetary policy to stimulate the economy. This combination is known as a monetary offset because the actions of the Federal Reserve offset the contractionary effects of the government's fiscal policy.

Question 13

Countercyclical policy will:

Accepted Answer

Countercyclical policy aims to reduce the volatility of the business cycle by using fiscal and monetary measures to counteract economic downturns and overheating, thereby stabilizing the economy.

Question 14

Which of the following is a procyclical policy?

Accepted Answer

Procyclical policies are those that amplify economic or business cycle fluctuations. Tax cuts during an economic expansion are procyclical because they can further stimulate an already growing economy.

Question 15

Which of the following is a countercyclical policy?

Accepted Answer

Countercyclical policies are economic policies that are implemented to counteract the economic cycle. Tax cuts made during a recession are an example of a countercyclical policy because they aim to stimulate economic activity by increasing disposable income when the economy is weak.

Question 16

A policy that is designed to move an economy in a direction that is the opposite of its direction in the business cycle is referred to as a _____ policy.

Accepted Answer

Countercyclical policies are designed to counteract the business cycle's fluctuations, aiming to stabilize the economy by working against the cycle's phases (e.g., stimulating the economy during a recession and cooling it during an expansion).

Question 17

Which of the following is an example of a countercyclical policy?

Accepted Answer

Countercyclical policies are measures taken by the government to counteract the business cycle. Increasing government purchases during a period of high unemployment is a countercyclical policy because it aims to stimulate economic activity and reduce unemployment.

Question 18

When government leaders choose a policy that moves an economy against the direction that it is naturally going in the business cycle, the leaders are using _____ policy.

Accepted Answer

Countercyclical policies are measures taken by the government to counter boom or bust phases of the business cycle, aiming to stabilize the economy by moving against the natural direction of the cycle.

Question 19

The effectiveness of fiscal policy is NOT affected by _____ lag.

Accepted Answer

A countercyclical lag is not a recognized type of lag in the context of fiscal policy effectiveness. Implementation, impact, and recognition lags are all relevant factors that can affect how effective fiscal policy is.

Question 20

The time period between the first drop in output and the realization that an economy is in a recession is referred to as the _____ lag.

Accepted Answer

The recognition lag refers to the time it takes for policymakers to recognize that an economy is in a recession following the initial signs of economic downturn, such as a drop in output.

Quiz 28: Fiscal Policy and the Business Cycle