Chapter 10

Question 1

1. Expansionary policies are policies:

Answer 1

b. that aim to increase the level of GDP.

Question 2

2. Stabilization policies are policies:

Answer 2

c. taken to move the economy closer to potential output.
(Policies do not want to undershoot, to avoid unnecessary unemployment, or
overshoot, and cause unnecessary inflation)

Question 3

3. Automatic stabilizers:

Answer 3

b. work without the need for decisions from Congress or the White House.

Question 4

Increases in government spending and/or decreases in taxes will ______ aggregate
demand.

Answer 4

Increase

Question 5

If the government wants to reduce unemployment, government spending should be
__________ and/or taxes should be __________.

Answer 5

increased; decreased.

Question 6

The basic idea of the fiscal multiplier is that an initial increase in government
spending will have a:

Answer 6

more than proportional impact on aggregate demand.
(What is important is why there is the multiplier. This is a primary point in the next
chapter 11, where the multiplier coefficient will be shown to be 1/(1-b), where b is the
marginal propensity to consume from the consumption function.)

Question 7

Congress and the President typically use what kind of spending to conduct fiscal
policies that affect the economy?

Answer 7

discretionary spending
(Fiscal policies that pursue economic stabilization are voted on and decided upon every budget cycle, hence are discretionary)

Question 8

Who sets the rules for “entitlements” when spending is authorized under this
category?

Answer 8

the Congress when it appropriates the spending

Question 9

What is the largest single component of federal revenue?

Answer 9

individual income taxes

Question 10

The largest category of discretionary federal spending is

Answer 10

funding for the Defense Department.

Question 11

In a situation where the government is operating on a budget surplus, it can reduce its
overall debt by _______

Answer 11

buying back bonds it has sold to the public.

Question 12

If the budget were balanced and the economy entered a period of recession, what
kind of budget would likely result?

Answer 12

deficit budget

Question 13

. Budget deficits tend to be procyclical for all the following reasons except

Answer 13

the selling of government securities to pay for the deficit spurs private investment
spending

Question 14

Although running a budget deficit during a recession should not be a source of
concern, running a budget deficit when there is no recession is a bad policy due to:

Answer 14

crowding out
(Increased government spending when there is full employment will cause
crowding out, i.e., reduce consumption and investment spending (see pp. 158-9))

Question 15

Tools of fiscial policy

Answer 15

gov spending and taxation

Question 16

3. Changes in government spending affect aggregate demand directly because

Answer 16

it is a direct component of AD (Y = C + I + G + NX).

Question 17

4. Changing taxes affects aggregate demand indirectly.

Answer 17

a. Changing taxes on income causes changes in the level of consumption, one of the four components of aggregate demand.
b. Changing taxes on businesses changes their incentives regarding investment spending: another component of aggregate demand.

Question 18

B. The Fiscal Multiplier

Answer 18

1. The existence of the multiplier allows for a greater total shift of the AD curve than the initial change.
2. The multiplier works through the impact on household income and thus consumption spending following an initial shock to aggregate demand.
3. The size of the multiplier is dependent on the size of the marginal propensity to consume.
4. Government policies designed to stabilize the economy must take into consideration the impact of the multiplier on their effects.

Question 19

Discretionary spending

Answer 19

is the spending programs that Congress authorizes on an annual basis

Question 20

Entitlement and mandatory spending

Answer 20

the spending that Congress has authorized by prior law, primarily providing support for individuals.

Question 21

1. Supply-side economics

Answer 21

s a school of thought that emphasizes the role that taxes play in the supply of output in the economy.

Question 22

2. The Laffer curve

Answer 22

shows a relationship between the tax rates and tax revenues that illustrates that high tax rates could lead to lower tax revenues if economic activity is severely discouraged (named after Arthur Laffer).