Question 1

Assume the marginal propensity to consume is 0.8 and potential output is $800 billion. If actual real GDP is $700 billion, which of the following policies would bring the economy to potential output?
A)Decrease taxes by $100 billion.
B)Increase taxes by $100 billion.
C)Decrease taxes by $25 billion.
D)Decrease government transfers by $25 billion.

Accepted Answer

The spending multiplier is 1/(1-MPC) = 1/(1-0.8) = 5. To close a $100 billion gap, a tax decrease of $25 billion would increase consumption by $20 billion, leading to a total increase in GDP of $100 billion (5 * $20 billion).

Question 2

Assume the marginal propensity to consume is 0.8 and potential output is $800 billion. If actual real GDP is $850 billion, which of the following policies would bring the economy to potential output?
A)Increase taxes by $50 billion.
B)Increase taxes by $10 billion.
C)Increase taxes by $12.5 billion.
D)Increase transfers by $12.5 billion.

Accepted Answer

To bring the economy to potential output, we need to decrease aggregate demand. We can achieve this by reducing disposable income, i.e. by either increasing taxes or decreasing transfers.

The MPC (marginal propensity to consume) is 0.8, which means that for every $1 increase in disposable income, consumption will increase by $0.80. Therefore, to decrease aggregate demand by $50 billion, we need to decrease disposable income by $62.5 billion (because 0.8 * $62.5 billion = $50 billion).

Option A, increasing taxes by $50 billion, would decrease disposable income by $50 billion, which is not enough to bring the economy to potential output. Option B, increasing taxes by $10 billion, would only decrease disposable income by $8 billion (0.8 * $10 billion = $8 billion), which is also not enough.

Option D, increasing transfers by $12.5 billion, would increase disposable income, which is not the desired result. Therefore, option C, increasing taxes by $12.5 billion, is the best choice. This would decrease disposable income by $10 billion (0.8 * $12.5 billion = $10 billion), which would reduce aggregate demand and bring the economy closer to potential output.

Question 3

When the economy expands, income tax receipts will:
A)rise, but sales tax revenues will remain the same.
B)fall, but sales tax revenues will rise.
C)stay the same unless the government changes the tax rates.
D)rise, and sales tax revenues will rise.

Accepted Answer

When the economy expands, people tend to spend more money, resulting in increased sales tax revenues. Additionally, as people earn more income, their income tax liability also increases, leading to a rise in income tax receipts. Therefore, both income tax receipts and sales tax revenues will rise.

Question 4

Which of the following is an automatic stabilizer?
A)military spending
B)unemployment compensation payments
C)disability payments to war veterans
D)Medicare payments

Accepted Answer

Unemployment compensation payments are automatic stabilizers because they automatically increase during a recession as more individuals become unemployed, which in turn boosts consumer spending and helps to stabilize the overall economy. The other options (A, C, D) are not automatic stabilizers because they do not automatically increase during a recession and may even be subject to political decisions and budget cuts.

Question 5

Congress increases personal income tax rates to balance the budget. Automatic stabilizers will _____ the _____ effect of the _____ in aggregate demand.
A)increase; contractionary; decrease
B)decrease; contractionary; decrease
C)increase; expansionary; increase
D)decrease; expansionary; increase

Accepted Answer

When Congress increases personal income tax rates, it decreases disposable income, which reduces consumption spending. This reduction in consumption spending is contractionary for the economy. Automatic stabilizers, such as increased transfer payments and decreased tax revenues, will mitigate the contractionary effect of the tax increase on aggregate demand. Therefore, the answer is B, which indicates that automatic stabilizers will decrease the contractionary effect of the tax increase on aggregate demand.

Question 6

Fiscal policies that require no government action but that are expansionary when the economy contracts and contractionary when the economy expands are known as:
A)discretionary fiscal policy.
B)automatic stabilizers.
C)autonomous spending policies.
D)destabilizing fiscal policies.

Accepted Answer

Automatic stabilizers are government policies that stabilize the economy without requiring any special actions from policymakers. They automatically respond to changes in economic conditions, such as changes in income, and provide an automatic stimulus or contraction to the economy. This is different from discretionary fiscal policy, which involves deliberate actions taken by the government in response to economic conditions.

Question 7

Suppose the government increases spending to fund tuition assistance for qualified college students. Automatic stabilizers will _____ the _____ effect of the _____ in aggregate demand.
A)increase; contractionary; decrease
B)decrease; contractionary; increase
C)increase; expansionary; increase
D)decrease; expansionary; increase

Accepted Answer

Automatic stabilizers, like taxes and unemployment benefits, work to smooth out economic fluctuations. When government spending increases, it boosts aggregate demand, creating an expansionary effect. Automatic stabilizers will decrease this expansionary effect by, for example, increasing tax revenues as incomes rise, thus moderating the increase in aggregate demand.

Question 8

Government tax revenue rises and falls with the business cycle as:
A)the multiplier effect of taxes and government transfers.
B)a discretionary fiscal policy.
C)the multiplier effect of government purchases.
D)an automatic stabilizer.

Accepted Answer

Government tax revenue is an example of an automatic stabilizer, meaning that it helps to stabilize the economy during fluctuations in the business cycle. As incomes fall during a recession, tax revenue declines, which helps to reduce the impact of the recession on individuals and businesses. Conversely, during an economic expansion, tax revenue increases as incomes rise, helping to prevent the economy from overheating. Automatic stabilizers function without the need for discretionary fiscal policy actions by the government.

Question 9

Use the following to answer questions :
Scenario: Fiscal Policy
Consider the economy of Arcadia. Its households spend 75% of increases in their income. There are no taxes and no foreign trade. Its currency is the arc. Potential output is 600 billion arcs.
-(Scenario: Fiscal Policy) Look at the scenario Fiscal Policy. Suppose actual real GDP in Arcadia is 500 billion arcs. This economy has:
A)a recessionary gap.
B)production at the full employment level.
C)an inflationary gap.
D)a liquidity trap.

Accepted Answer

Since the potential output is 600 billion arcs and the actual real GDP is only 500 billion arcs, there is a gap between the potential output and the actual output. This suggests that the economy is producing below its full capacity and experiencing a recessionary gap.

Question 10

An automatic stabilizer that works when the economy contracts is:
A)a rise in tax receipts.
B)a fall in government purchases.
C)a discretionary decrease in government purchases.
D)a rise in government transfers as more people receive unemployment insurance benefits.

Accepted Answer

An automatic stabilizer that works when the economy contracts is a rise in government transfers as more people receive unemployment insurance benefits. This is because as unemployment increases during a recession, more people become eligible for and receive unemployment insurance benefits, which in turn increases government transfers. This increase in transfers helps to mitigate the negative effects of the recession on individuals and helps to stabilize the economy overall.

Question 11

When the economy is in a recession, tax receipts _____ and unemployment insurance payments _____.
A)decrease; increase
B)increase; increase
C)increase; decrease
D)decrease; decrease

Accepted Answer

During a recession, tax receipts decrease as people have lower income and businesses have lower profits. On the other hand, unemployment insurance payments increase as more people lose their jobs and file for unemployment benefits.

Question 12

An example of an automatic stabilizer is:
A)tax receipts rising when GDP rises.
B)a discretionary increase in taxes.
C)government purchases of goods and services rising when GDP rises.
D)government transfers rising when GDP rises.

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. Tax receipts rising when GDP rises is an example of an automatic stabilizer because it happens automatically as incomes increase, leading to higher tax revenues.

Question 13

Which statement is CORRECT?
A)Automatic stabilizers indicate deliberate action by policy makers.
B)Discretionary fiscal policy shows automatic adjustments without any specific effort by policy makers.
C)Discretionary fiscal policy indicates deliberate action by policy makers.
D)Automatic stabilizers are risky to use and sometimes can get the economy destabilized.

Accepted Answer

Discretionary fiscal policy involves deliberate actions taken by policy makers, such as changes in government spending or taxes. Automatic stabilizers, on the other hand, are built-in features of the economy that automatically help stabilize economic fluctuations, such as unemployment insurance or progressive income taxes. Therefore, option C is the correct statement. Option A is incorrect because automatic stabilizers operate without deliberate action by policy makers. Option B is incorrect because it describes automatic stabilizers, not discretionary fiscal policy. Option D is incorrect because automatic stabilizers are designed to help stabilize the economy, not destabilize it.

Question 14

If the government increases its spending when the economy is expanding, automatic stabilizers _____ the government spending multiplier.
A)may or may not affect
B)will increase
C)will not affect
D)will decrease

Accepted Answer

When the economy is expanding, tax revenues increase automatically because people and businesses earn more money and pay more taxes. At the same time, spending on programs like unemployment and welfare may decrease as fewer people need them. This means that the government's increased spending will have a smaller impact on aggregate demand because the automatic stabilizers are already working to stabilize the economy. Therefore, the government spending multiplier will be lower than if the automatic stabilizers were not in place, leading to a decrease in the multiplier.

Question 15

Because the revenue from personal income taxes increases as disposable income increases:
A)the multiplier effect decreases.
B)the marginal propensity to consume decreases as income increases.
C)the multiplier effect increases.
D)the marginal propensity to save increases as income decreases.

Accepted Answer

Automatic stabilizers like personal income taxes reduce the multiplier effect because they decrease the amount of additional income that is spent when income increases.

Question 16

Discretionary fiscal policy refers to changes in:
A)interest rates.
B)the money supply.
C)government spending or taxes to close a recessionary or inflationary gap.
D)taxes to account for externalities and control pollution.

Accepted Answer

Discretionary fiscal policy refers to deliberate changes in government spending or taxation designed to close a recessionary or inflationary gap. It involves the actions taken by policymakers to influence the economy's level of activity, such as increasing government spending and/or reducing taxes during a recession to stimulate economic growth or decreasing government spending and/or raising taxes during an economic boom to combat inflation. Discretionary fiscal policy is distinct from automatic stabilizers, such as unemployment insurance or progressive taxation, which naturally stabilize economic activity without any need for legislative action.

Question 17

Government transfer payments rise when the economy is contracting and fall when the economy is expanding. In this role, transfer payments are described as:
A)automatic stabilizers.
B)discretionary fiscal policy.
C)balanced budget policy.
D)deficit reduction policy.

Accepted Answer

Automatic stabilizers are government policies that automatically stabilize economic activity during economic downturns without any additional government actions. Transfer payments are one example of automatic stabilizers because they increase during a recession, providing additional income support to individuals and families who may be struggling financially.

Question 18

Automatic stabilizers are government spending and taxation changes that cause fiscal policy to be _____ when the economy contracts.
A)expansionary
B)contractionary
C)neutral
D)ineffective

Accepted Answer

Automatic stabilizers, such as unemployment benefits and progressive taxes, increase government spending or decrease taxes when the economy contracts, making fiscal policy expansionary to help stabilize the economy.

Question 19

The automatic stabilizer in government tax revenue that occurs when GDP rises _____ the multiplier.
A)has no effect on
B)increases
C)decreases
D)may either increase or decrease

Accepted Answer

Automatic stabilizers, like progressive taxes, reduce the multiplier effect because they dampen the fluctuations in GDP by automatically adjusting tax revenues with changes in economic activity.

Question 20

The fact that tax receipts fall during a recession:
A)makes the multiplier stronger.
B)has no impact on the multiplier.
C)reduces the adverse effect of the initial fall in aggregate demand.
D)acts as an automatic contractionary fiscal policy.

Accepted Answer

During a recession, tax receipts fall, which can help stabilize the economy by leaving more money in the hands of consumers and businesses, thereby reducing the adverse effect of the initial fall in aggregate demand. This acts as an automatic stabilizer.

Quiz 13: Fiscal Policy Appendix Taxes and the Multiplier

Assume the marginal propensity to consume is 0.8 and potential output is $800 billion. If actual real GDP is $700 billion, which of the following policies would bring the economy to potential output?

Assume the marginal propensity to consume is 0.8 and potential output is $800 billion. If actual real GDP is $850 billion, which of the following policies would bring the economy to potential output?

When the economy expands, income tax receipts will:

Which of the following is an automatic stabilizer?

Congress increases personal income tax rates to balance the budget. Automatic stabilizers will ___ the _ effect of the ___ in aggregate demand.

Fiscal policies that require no government action but that are expansionary when the economy contracts and contractionary when the economy expands are known as:

Suppose the government increases spending to fund tuition assistance for qualified college students. Automatic stabilizers will ___ the _ effect of the ___ in aggregate demand.

Government tax revenue rises and falls with the business cycle as:

An automatic stabilizer that works when the economy contracts is:

When the economy is in a recession, tax receipts _ and unemployment insurance payments _.

An example of an automatic stabilizer is:

Which statement is CORRECT?

If the government increases its spending when the economy is expanding, automatic stabilizers _____ the government spending multiplier.

Because the revenue from personal income taxes increases as disposable income increases:

Discretionary fiscal policy refers to changes in:

Government transfer payments rise when the economy is contracting and fall when the economy is expanding. In this role, transfer payments are described as:

Automatic stabilizers are government spending and taxation changes that cause fiscal policy to be _____ when the economy contracts.

The automatic stabilizer in government tax revenue that occurs when GDP rises _____ the multiplier.

The fact that tax receipts fall during a recession: