Question 1

If the government increases spending and there is a complete direct expenditure offset, then
A) aggregate demand and real Gross Domestic Product (GDP) will not change.
B) aggregate demand and real Gross Domestic Product (GDP) will increase by the amount of the spending increase.
C) the price level will drop.
D) the government spending multiplier will be greater than zero.

Accepted Answer

If there is a complete direct expenditure offset, it means that any increase in government spending is fully offset by an equal decrease in private spending or investment. Therefore, there will be no net increase in aggregate demand or real GDP.

Question 2

The supporters of a proposal to increase marginal taxes on those earning over $200,000 a year say this change would generate $100 billion in new tax revenues. A supply-side economist would argue that the actual revenue raised will be
A) less than $100 billion because some people will respond by working less.
B) exactly $100 billion because there are no offsetting factors to a tax increase.
C) more than $100 billion, because lower income people will work harder when they perceive the tax system to be fairer.
D) more than $100 billion because interest rates will also be affected.

Accepted Answer

A supply-side economist would argue that increasing taxes on high earners would disincentivize them from working as hard or seeking out new opportunities. This would result in a decrease in taxable income and ultimately a lower amount of revenue generated than the projected $100 billion. Therefore, the actual revenue raised would be less than $100 billion because some people will respond by working less.

Question 3

The government wants to increase its spending by $1 billion to stimulate the economy and is counting on the government spending multiplier to help. Taking into account direct expenditure offset effects, what is its best spending option?
A) A new cruise missile for the military
B) Expanding the school lunch program
C) Constructing more low income housing
D) Providing textbooks for college students

Accepted Answer

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

Question 4

The Ricardian equivalence theorem states that
A) an increase in government spending has no effect on aggregate supply.
B) increases in government spending have a larger impact on real Gross Domestic Product (GDP) than decreases in taxes.
C) an increase in the government budget deficit created by a current tax cut has no effect on aggregate demand.
D) an increase in the government budget deficit has no effect on real Gross Domestic Product (GDP) because it only affects the price index.

Accepted Answer

The Ricardian equivalence theorem states that an increase in the government budget deficit created by a current tax cut has no effect on aggregate demand. This is because individuals will increase their savings in anticipation of the future tax increase required to pay off the debt incurred by the tax cut, offsetting any increase in government spending. Therefore, the deficit-financed tax cut does not stimulate consumer spending or economic growth.

Question 5

The concept that increased government spending will lead to lower investment and consumer spending is referred to as the
A) inflationary effect.
B) crowding-out effect.
C) aggregate demand effect.
D) Keynesian effect.

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 when government spending increases, it often leads to an increase in interest rates, which can discourage private investment and make borrowing more expensive for consumers, ultimately leading to a decrease in overall spending. The other choices are not accurate descriptions of this phenomenon.

Question 6

The Laffer curve shows a relationship between
A) inflation rates and unemployment rates.
B) interest rates and investment spending.
C) price level and real Gross Domestic Product (GDP).
D) tax rates and tax revenues.

Accepted Answer

The Laffer curve shows the relationship between tax rates and tax revenue. It suggests that as tax rates increase from zero, tax revenue also increases, but there comes a point where further increases in tax rates will lead to a decrease in tax revenue as people's incentives to work and invest decrease. Therefore, the Laffer curve helps policymakers determine the optimal tax rate at which tax revenue is maximized.

Question 7

Supply-side economists argue that
A) lower tax rates sometimes lead to increased tax revenues.
B) higher tax rates lead to increased productivity.
C) lower tax rates lead to a drop in real Gross Domestic Product (GDP).
D) lower tax rates always lead to lower tax revenues.

Accepted Answer

Supply-side economists believe that lower tax rates can incentivize people to work harder and invest more, which can lead to increased economic activity and ultimately, increased tax revenues. This is known as the Laffer Curve. However, it's important to note that this theory is controversial and not universally accepted.

Question 8

According to supply-side economics, changes in marginal tax rates will have which of the following effects?
A) change the incentive to work
B) change the incentive to save
C) change the incentive to invest
D) all of the above

Accepted Answer

Supply-side economics theory suggests that changes in marginal tax rates can impact the incentives to work, invest, and save. Lower marginal tax rates can provide greater incentives to work and invest as individuals and businesses keep more of their earnings or profits. Lower marginal tax rates can also encourage greater savings as individuals have more disposable income to save. Therefore, all of the above options are correct.

Question 9

When supply-side policy is successful in pushing up equilibrium real Gross Domestic Product (GDP), the reason is that the policy generates
A) a decrease in aggregate demand.
B) an increase in aggregate supply.
C) a decrease in employment.
D) a decrease in saving.

Accepted Answer

Supply-side policy focuses on increasing the production of goods and services through various measures such as tax cuts, deregulation, and investment in technology and infrastructure. These policies aim to increase the potential output of an economy, which shifts the aggregate supply curve to the right. As a result, the equilibrium real GDP increases, without necessarily affecting aggregate demand. Therefore, the correct choice is an increase in aggregate supply (option B).

Question 10

Supply-side economics focuses on tax cuts to stimulate
A) aggregate demand by reducing saving.
B) aggregate supply by increasing production.
C) government spending.
D) military research.

Accepted Answer

Supply-side economics is based on the idea that cutting taxes will incentivize individuals and businesses to increase production and supply, leading to an increase in aggregate supply. This increase in supply can then lead to economic growth and lower inflation.

Question 11

The tendency for expansionary fiscal policy to cause a reduction in planned real investment spending by the private sector is called
A) the indirect effect.
B) the interest rate effect.
C) the crowding-out effect.
D) the Laffer effect.

Accepted Answer

The crowding-out effect is the tendency for expansionary fiscal policy (such as increased government spending and/or tax cuts) to lead to higher interest rates, which in turn reduces planned real investment spending by the private sector. This occurs because the increased demand for loanable funds (from the government) drives up interest rates, making borrowing more expensive for businesses and households, and therefore reducing their willingness and ability to invest.

Question 12

The crowding-out effect is
A) the tendency of contractionary fiscal policy to cause an increase in planned investment or planned consumption in the U.S. private sector.
B) the tendency of expansionary fiscal policy to cause an increase in planned investment but not in planned consumption in the U.S. private sector.
C) the tendency of expansionary fiscal policy to cause a decrease in planned investment or planned consumption in the U.S. private sector.
D) the tendency of contractionary fiscal policy to cause an increase in planned investment but a decrease in planned consumption in the U.S. private sector.

Accepted Answer

The crowding-out effect refers to the tendency of expansionary fiscal policy (such as increased government spending or tax cuts) to increase interest rates, which in turn inhibits private sector investment and consumption. This decrease in investment and consumption is referred to as "crowding out." Therefore, option C, which states "the tendency of expansionary fiscal policy to cause a decrease in planned investment or planned consumption in the U.S. private sector," is the correct answer.

Question 13

The crowding-out effect is
A) due to the upward slope of the SRAS when the economy is operating to the right of the LRAS curve.
B) due to the government being more powerful in the markets when there is an increase in government spending.
C) a situation in which expansionary fiscal policy leads to a decrease in planned real investment or planned real consumption in the private sector.
D) only relevant when an inflationary gap is present.

Accepted Answer

The crowding-out effect refers to the decrease in planned real investment or real consumption in the private sector that occurs when expansionary fiscal policy (such as government spending) leads to higher interest rates, which can make it more expensive for private individuals and firms to borrow money. As a result, private investment and consumption may decrease, or be "crowded out," leading to a potential decrease in overall economic growth.

Question 14

One part of the supply-side argument is that
A) lower marginal tax rates are required to induce Congress to reduce government spending.
B) lower marginal tax rates can increase total tax revenues.
C) the marginal tax rate should be set at 50 percent.
D) the relevant aggregate supply curve is close to horizontal.

Accepted Answer

The supply-side argument suggests that by lowering marginal tax rates, people and businesses will have more incentive to work, save, and invest, leading to higher economic growth and ultimately generating more tax revenue for the government. While this argument has been a topic of debate among economists, empirical evidence has shown that in some cases, lower marginal tax rates have led to increased tax revenue. Therefore, choice B is the best answer.

Question 15

At tax rates higher than the tax rate that maximizes tax revenues along a Laffer curve,
A) an increase in tax rates increases tax revenues.
B) a reduction in tax rates reduces tax revenues.
C) a reduction in tax rates increases tax revenues.
D) any variation in tax rates has no effect on tax revenues.

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 16

If the government increases spending but does not raise taxes,
A) aggregate demand will increase without any effect on the price level.
B) borrowing by the government will take place.
C) the government will have to sell some assets, such as oil and national parks.
D) the government will have to either lower expenditures or raise taxes the next year.

Accepted Answer

If the government increases spending but does not raise taxes, it will lead to borrowing by the government to finance the increased spending. This can result in a budget deficit, as government spending exceeds revenue from taxes and other sources. Therefore, the government will need to borrow to finance the deficit.

Question 17

According to supply-side economists, lower marginal tax rates will not necessarily lead to lower tax revenues because
A) the crowding out effect does not apply to taxes.
B) lower tax rates have no effect on the opportunity cost of labor.
C) the aggregate supply curve will shift inward to the left if the tax rates are lowered.
D) the lower marginal tax rates will be applied to a growing tax base due to economic growth.

Accepted Answer

Supply-side economists believe that lower marginal tax rates will stimulate economic growth and increase the size of the tax base, resulting in higher tax revenues despite lower tax rates. This is based on the idea that lower taxes will incentivize individuals and businesses to work harder, invest more, and innovate, which will lead to higher productivity and economic growth. Therefore, the lower marginal tax rates will be applied to a larger tax base, resulting in increased tax revenue.

Question 18

By definition, a direct expenditure offset will occur whenever
A) the government increases spending in an area that competes with the private sector.
B) the government increases spending for the military.
C) the interest rate rises.
D) the interest rate falls.

Accepted Answer

A direct expenditure offset occurs when the government spends more money in an area that competes with the private sector, causing private sector spending to decrease. This can happen, for example, when the government increases spending on public education, which may lead to a decrease in demand for private education services.

Question 19

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
A) an increase in real Gross Domestic Product (GDP).
B) a direct expenditure offset.
C) a Ricardian dilemma.
D) a reduction of the government deficit.

Accepted Answer

Providing free textbooks to college students would result in a direct expenditure offset, as the money that would have been spent on textbooks in the private sector would now be spent by the government. This would potentially reduce demand for textbooks in the private sector, causing a negative impact on the textbook industry. However, it would not necessarily result in an increase in real GDP, a Ricardian dilemma, or a reduction of the government deficit.

Question 20

If the government increases spending while holding taxes constant, we expect
A) an increase in investment spending by businesses too, as they anticipate future economic growth.
B) a decrease in real saving as consumers follow suit and also increase borrowing.
C) planned real investment spending by businesses to increase.
D) interest rates to rise.

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.

Quiz 13: Fiscal Policy

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

The supporters of a proposal to increase marginal taxes on those earning over $200,000 a year say this change would generate $100 billion in new tax revenues. A supply-side economist would argue that the actual revenue raised will be

The government wants to increase its spending by $1 billion to stimulate the economy and is counting on the government spending multiplier to help. Taking into account direct expenditure offset effects, what is its best spending option?

The Ricardian equivalence theorem states that

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

The Laffer curve shows a relationship between

Supply-side economists argue that

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

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

Supply-side economics focuses on tax cuts to stimulate

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

The crowding-out effect is

The crowding-out effect is

One part of the supply-side argument is that

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

If the government increases spending but does not raise taxes,

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

By definition, a direct expenditure offset will occur whenever

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

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