Question 1

The "crowding out" effect suggests that:

Accepted Answer

The crowding out effect suggests that an increase in government spending leads to a decrease in private investment because the government funds its increase in spending by borrowing from the private sector, pushing up interest rates and reducing the funds available for private investment. Therefore, choice A is the best answer.

Question 2

Like households and businesses, the provincial and municipal governments increase their expenditure during good times and cut them during recession. As a result of such a practice:

Accepted Answer

The answer of Like households and businesses, the provincial and...

Question 3

Assume the government incurs a budget deficit which is financed by borrowing. As a result, interest rates rise and the volume of private investment spending declines. This illustrates:

Accepted Answer

This scenario describes the crowding-out effect, which occurs when government borrowing leads to higher interest rates that then discourage private investment. The other options (equation-of-exchange effect, paradox of thrift, and money-fund effect) do not accurately describe this situation.

Question 4

If the policy makers implement a tax cut as a discretionary fiscal policy to combat a recessionary gap, it may fail to achieve its objective if:

Accepted Answer

If households perceive the tax cut as temporary, they may not increase their consumption as much as expected since they may save the extra income in anticipation of higher taxes in the future. Therefore, the tax cut may not stimulate enough demand to close the recessionary gap. On the other hand, if households think of the tax cut as a permanent policy, they may increase spending more, which can lead to an over-heating of the economy and inflation. Option A, C, and D are not likely to affect the effectiveness of the tax cut in closing the recessionary gap.

Question 5

Crowding-out is the notion that:

Accepted Answer

Crowding-out occurs when increased government spending or budget deficits lead to higher interest rates, which in turn reduce private investment spending. This can happen because of increased demand for money in the economy, and higher interest rates reduce the attractiveness of borrowing for firms and individuals. This can also reduce overall economic growth and limit the expansion of the economy. Option A describes the relationship between GDP and tax revenues but is not directly related to crowding-out. Option C is not accurate as the full-employment budget is used to estimate the budget deficit when the economy is operating at full-employment levels. Option D is also not accurate as the budget deficit is not directly related to saving but rather can impact interest rates and investment spending.

Question 6

If the government increases its spending during recession to assist the economy, the funds for such expenditures must come from some source. Which of the following sources would be the most expansionary?

Accepted Answer

Creating new money is the most expansionary source because it involves increasing the money supply, which can stimulate economic growth and increase aggregate demand. Additional taxes on personal incomes and corporate profits would reduce available funds for consumer spending and investment, respectively, and would be contractionary. Borrowing from the public can also have a contractionary effect by reducing the amount of funds available for private investment.

Question 7

The financing of a government deficit increases interest rates and, as a result, reduces investment spending. This statement describes:

Accepted Answer

The statement is describing the crowding-out effect, which occurs when government borrowing to finance a deficit leads to an increase in interest rates. This increase in interest rates makes it more expensive for businesses to borrow and invest, reducing investment spending and crowding out private investment.

Question 8

The greatest expansionary impact of a budget deficit will occur when the:

Accepted Answer

The answer of The greatest expansionary impact of a budget...

Question 9

The net export effect works through international trade to:

Accepted Answer

The net export effect refers to the impact of changes in international trade on a country's overall level of economic activity. Specifically, if a country experiences an increase in net exports (meaning exports minus imports), this will increase aggregate demand and GDP. Conversely, a decrease in net exports will decrease aggregate demand and GDP. This means that changes in international trade can either amplify or dampen the impact of expansionary or contractionary fiscal policy. In general, if a country is experiencing an increase in net exports, expansionary fiscal policy will be more effective because the increased demand from the exports will complement the new demand generated by the fiscal policy. However, if a country is experiencing a decrease in net exports, this will reduce the effectiveness of both expansionary and contractionary fiscal policy because the changes in international trade will partially offset the impact of the policy. Therefore, the correct choice is B, which states that the net export effect decreases the effectiveness of both expansionary and contractionary fiscal policy.

Question 10

If the government adopts a fiscal policy that is:

Accepted Answer

The answer of If the government adopts a fiscal policy...

Question 11

Which of the following best describes the notion of a "political business cycle"?

Accepted Answer

The political business cycle refers to the notion that politicians will use fiscal policy to manipulate the economy in order to create favorable economic conditions, such as rising output, real incomes, and employment, prior to elections in order to increase their chances of re-election. This pattern can result in a predictable cycle of economic booms and busts driven by political motivations rather than sound economic policy.

Question 12

If a deficit is financed by issuing new money, the:

Accepted Answer

The answer of If a deficit is financed by issuing...

Question 13

The crowding-out effect suggests that:

Accepted Answer

The crowding-out effect suggests that increases in government spending may raise the interest rate and thereby reduce investment. This is because when the government increases its spending, it needs to borrow more money to finance it, which increases the demand for credit in the market. This, in turn, increases the interest rate, making it more expensive for businesses and individuals to borrow, which reduces investment and can thereby offset the initial increase in aggregate demand caused by the government spending. Hence, choice C is the correct answer.

Question 14

Which cause-and-effect chain would best explain the reason for a decline in net exports? An expansionary fiscal policy:

Accepted Answer

An expansionary fiscal policy involves an increase in government spending or a decrease in taxes, which leads to an increase in aggregate demand in the economy. This increase in demand leads to an increase in domestic interest rates, which attracts foreign investors to invest in the domestic economy. This increases the demand for domestic currency, which in turn leads to an appreciation of the dollar. As the dollar appreciates, exports become more expensive for foreign buyers and imports become cheaper for domestic consumers, leading to a reduction in net exports.

Question 15

The crowding-out effect arises when:

Accepted Answer

The crowding-out effect refers to the reduction in private investment due to government borrowing, which increases interest rates in the economy. Therefore, option B correctly describes the effect of government borrowing on interest rates and net investment spending. Option A is partially correct but fails to mention the impact on net investment spending. Options C and D are incorrect as they incorrectly describe the relationship between tax progressivity and interest rates/net investment spending.

Question 16

An expansionary fiscal policy can be partially offset by a(n):

Accepted Answer

An expansionary fiscal policy is aimed at increasing aggregate demand, which can lead to an increase in imports and a decrease in net exports. Therefore, a decrease in net exports can partially offset the impact of the expansionary fiscal policy. Options A and B are incorrect because they would further increase the impact of the expansionary fiscal policy. Option C may have an impact on net exports, but it is not directly related to the expansionary fiscal policy.

Question 17

Which policy to finance the public debt might crowd-out private spending?

Accepted Answer

When the government borrows money from the public in the money market, it competes with other borrowers for the available funds, which can drive up interest rates. This increase in interest rates can lead to a decrease in private spending as individuals and businesses face higher borrowing costs. This is known as crowding-out. Therefore, policy A might crowd-out private spending.

B) Decreasing government spending can actually increase private spending as it leaves more money in the hands of individuals and businesses, which they can spend or save.

C) Creating new money (also known as printing money) can lead to inflation, which can also lead to a decrease in private spending as individuals and businesses face higher prices for goods and services. This is another form of crowding-out, but it is not caused by borrowing from the public.

D) Decreasing taxes can increase private spending as individuals and businesses have more disposable income.

Question 18

Which set of events would best explain the effects of a contractionary fiscal policy on net exports?

Accepted Answer

The answer of Which set of events would best explain...

Question 19

Other things being equal, which of the policies will have the most expansionary effect on the economy?

Accepted Answer

A budget deficit financed by creating new money is the most expansionary policy because the increase in the money supply directly stimulates aggregate demand and economic activity. A balanced budget or a budget surplus may be contractionary, as they reduce aggregate demand by removing money from circulation. Using a budget surplus for debt retirement may have some stimulus effect, but not as much as creating new money, as the latter increases the overall money supply in the economy.

Question 20

The "crowding-out effect" suggests that:

Accepted Answer

The crowding-out effect suggests that increases in government spending financed through borrowing will increase the interest rate and thereby reduce investment. This happens because the government is competing for a limited pool of savings with private investors, and when the government borrows more money, it drives up interest rates. This can discourage private investment and slow economic growth.

Quiz 11: Fiscal Policy, Deficits, Surpluses, and Debt