Question 1

Discretionary government spending is an automatic stabilizer.

Accepted Answer

Discretionary government spending requires deliberate action by policymakers and is not automatic. Automatic stabilizers, like unemployment benefits, adjust with economic conditions without new government action.

Question 2

Automatic stabilizers are government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands.

Accepted Answer

Automatic stabilizers refer to the predetermined government policies that adjust spending and taxes during economic fluctuations. For example, during a recession, people may experience job losses and lower incomes leading to decreased consumption; automatic stabilizers would respond by increasing government spending on social welfare programs, such as unemployment benefits or food stamps, and decreasing taxes to stimulate consumption, leading to an automatic expansionary fiscal policy. Similarly, during an economic boom, automatic stabilizers would reduce government spending and increase taxes to cool off the economy, leading to an automatic contractionary fiscal policy.

Question 3

The multiplier effect of an increase in transfer payments is smaller than that of an equal increase in government purchases of goods and services because some of the transfer payment is likely to be saved.

Accepted Answer

Transfer payments are payments made by the government to individuals or households without any corresponding production of goods or services. Examples include social security checks and unemployment benefits. While these payments can stimulate demand and consumption, some recipients may choose to save some of the money rather than spending it immediately. In contrast, an increase in government purchases of goods and services directly stimulates production and employment, leading to a larger multiplier effect.

Question 4

For a marginal propensity to consume of 0.9, the multiplier effect of an increase of $100 billion in government purchases of goods and services is smaller than the multiplier effect of a tax cut of $100 billion.

Accepted Answer

The multiplier effect of government purchases of goods and services is given by the formula:
Multiplier effect = 1 / (1 - MPC)
where MPC is the marginal propensity to consume.
In this case, with an MPC of 0.9, the multiplier effect is:
Multiplier effect = 1 / (1 - 0.9) = 10
So an increase of $100 billion in government purchases of goods and services would have a multiplier effect of $100 billion x 10 = $1 trillion.
The multiplier effect of a tax cut, on the other hand, is given by the formula:
Multiplier effect = MPC / (1 - MPC)
In this case, with an MPC of 0.9, the multiplier effect would be:
Multiplier effect = 0.9 / (1 - 0.9) = 9
So a tax cut of $100 billion would have a multiplier effect of $100 billion x 9 = $900 billion.
Therefore, the statement is false. The multiplier effect of an increase in government purchases is actually larger than the multiplier effect of a tax cut.

Question 5

If policy makers want to increase real GDP by $100 billion and the marginal propensity to consume is 0.75, they should increase government transfers by $75 billion.

Accepted Answer

The correct increase in government transfers should be $25 billion, not $75 billion, because the spending multiplier is 1/(1-MPC) = 4, so $25 billion in transfers will lead to a $100 billion increase in GDP.

Question 6

The tax and government transfer payment multiplier is smaller than the government purchases multiplier because all of an increase in government purchases is spent, only some of tax cuts or increases in government transfers is spent.

Accepted Answer

The government purchases multiplier is larger because it directly increases aggregate demand, while tax cuts or transfers only indirectly affect demand as recipients may save part of the additional income.

Question 7

Suppose the marginal propensity to consume is 0.8. If the government cut taxes by $100 billion, then real GDP would increase by $400 billion.

Accepted Answer

If the marginal propensity to consume is 0.8, then the multiplier is 1/1-MPC = 1/0.2 = 5. This means that a $100 billion tax cut would lead to a $500 billion increase in real GDP (5 times the tax cut). Therefore, the statement that real GDP would increase by $400 billion is false, and the correct answer is A.

Question 8

Medicaid, food stamps, and sales taxes are all automatic stabilizers.

Accepted Answer

Automatic stabilizers refer to government programs or policy measures that automatically adjust themselves to cushion the economy against shocks without any additional government action. Medicaid, food stamps, and sales taxes are all examples of automatic stabilizers. Medicaid and food stamp programs provide assistance to low-income households during economic downturns, while sales taxes automatically reduce during recessions as consumer spending decreases.

Question 9

Discretionary fiscal policy is the direct result of deliberate actions by policy makers rather than an automatic adjustment.

Accepted Answer

Discretionary fiscal policy is designed and implemented by policy makers in response to changes in economic conditions, rather than being automatically triggered by predefined rules or formulas. This type of policy involves deliberate government actions to adjust spending, taxation, or transfer payments with the goal of stabilizing the economy.

Question 10

Automatic stabilizers are government spending and taxation rules that cause fiscal policy to be automatically contractionary when the economy contracts and automatically expansionary when the economy expands.

Accepted Answer

Automatic stabilizers work in the opposite way; they are designed to be expansionary during economic contractions (e.g., increased unemployment benefits) and contractionary during economic expansions (e.g., higher tax revenues).

Question 11

A lump sum tax is a tax whose rate increases as income increases.

Accepted Answer

A lump sum tax is a fixed tax amount that is the same for everyone, regardless of their income level. It is not a progressive tax, which is a tax that increases as income increases.

Question 12

Taxes increase as GDP rises. This is an example of an automatic stabilizer.

Accepted Answer

Automatic stabilizers are government programs or policies that are designed to reduce the impact of economic fluctuations on individuals and businesses without any explicit government action. Taxes are one of the most common automatic stabilizers. As the economy grows and GDP rises, people's incomes increase and they pay more in taxes, which helps reduce inflationary pressures and stabilizes the economy. Conversely, during an economic downturn, incomes and tax revenues decrease, which can help to stimulate demand and reduce the severity of the downturn.

Question 13

The effect of automatic stabilizers is to increase the size of the multiplier.

Accepted Answer

Automatic stabilizers work to dampen the fluctuations in the economy, reducing the multiplier effect by offsetting changes in aggregate demand.

Question 14

The Works Progress Administration, a government program that put millions of unemployed Americans to work building bridges, roads, and parks in the 1930s, was an automatic stabilizer.

Accepted Answer

Automatic stabilizers are economic policies and programs designed to offset fluctuations in a nation's economic activity without intervention by the government or policymakers, such as unemployment insurance. The Works Progress Administration was a discretionary fiscal policy, not an automatic stabilizer.

Question 15

A budget deficit necessarily indicates that fiscal policy is expansionary.

Accepted Answer

A budget deficit occurs when government spending exceeds revenue, but it does not necessarily mean fiscal policy is expansionary, as it could result from decreased revenue during a recession rather than increased spending.

Question 16

If policy makers want to decrease real GDP by $100 billion and the marginal propensity to consume is 0.6, they should increase taxes by more than $40 billion.

Accepted Answer

The tax multiplier is smaller than the spending multiplier. With an MPC of 0.6, the tax multiplier is -0.6/(1-0.6) = -1.5. To decrease GDP by $100 billion, taxes need to be increased by more than $100 billion / 1.5 = $66.67 billion, which is more than $40 billion.

Question 17

If government purchases decrease so the budget may be balanced, some government transfers will automatically increase, reducing the multiplier effect.

Accepted Answer

Government transfers, such as unemployment benefits and welfare payments, act as automatic stabilizers in the economy. When government purchases decrease, individuals who receive these transfers may have increased need for them, leading to an automatic increase in the transfer payments. However, these transfers have a lower multiplier effect compared to government purchases, meaning their impact on GDP is not as significant. Therefore, a decrease in government purchases can lead to a decrease in the overall multiplier effect in the economy.

Question 18

If the marginal propensity to consume is 0.8, the multiplier for taxes and transfer payments will be more than 5.

Accepted Answer

The tax multiplier is calculated as -MPC/(1-MPC). With an MPC of 0.8, the tax multiplier is -0.8/(1-0.8) = -4, which is less than 5.

Question 19

If the marginal propensity to consume is 0.8 and government transfers decrease by $30 billion, real GDP will decrease by less than $150 billion.

Accepted Answer

The decrease in real GDP is calculated using the spending multiplier, which is 1/(1-MPC). With an MPC of 0.8, the multiplier is 5. A $30 billion decrease in transfers leads to a $30 billion decrease in consumption, reducing GDP by $30 billion * 5 = $150 billion. However, since transfers are not direct spending, the initial impact is less than $30 billion, leading to a GDP decrease of less than $150 billion.

Question 20

The tax multiplier for someone living below the poverty line is smaller than the tax multiplier for someone with an annual income of $1 million.

Accepted Answer

The tax multiplier is generally larger for lower-income individuals because they are more likely to spend additional income, whereas higher-income individuals may save more, reducing the multiplier effect.

Quiz 13: Fiscal Policy Appendix Taxes and the Multiplier