Economics Module 15

Question 1

What happens to real GDP, employment, and prices if government spending increases? Assume we start in a long-run equilibrium for the economy and then move to a new short-run equilibrium.

Answer 1

Real GDP rises, employment rises, and prices rise

Question 2

What happens to real GDP, employment, and prices if income taxes increase? Assume we start in a long-run equilibrium and then move to a new short-run equilibrium. Choose one of the following:

Answer 2

Real GDP falls, employment falls, and prices fall

Question 3

What happens to real GDP, employment, and prices if transfer payments decrease? Assume we start in a long-run equilibrium and then move to a new short-run equilibrium. Choose one of the following.

Answer 3

Real GDP falls, employment falls, and prices fall

Question 4

Suppose we are facing a recession. Use our models to make policy recommendations.

Answer 4

Raise government spending, lower taxes, increase transfer payments

Question 5

Why were the temporary tax changes, discussed above in section 15.2.5, not successful?

Answer 5

Temporary tax changes affect only current but not future income

Question 6

Per-child tax Credit would primarily affect:

Answer 6

Aggregate demand

Question 7

Education tax incentives would primarily affect:

Answer 7

Aggregate demand and Aggregate supply

Question 8

Capital gains tax cuts would primarily affect:

Answer 8

Aggregate supply

Question 9

Estate tax cuts would primarily affect:

Answer 9

Aggregate demand and Aggregate supply

Question 10

2001 change to income tax:

Answer 10

Demand-side

Question 11

2002 tax change to investment:

Answer 11

Supply-side

Question 12

2003 tax change:

Answer 12

Demand- and supply-side

Question 13

Why would Alan Greenspan care about fiscal policy?

Answer 13

Monetary and fiscal policies interact

Question 14

Suppose that the marginal propensity to consume is 0.75 and that the federal government increased spending by $0.5 trillion. How would we model the change to aggregate demand? Assume there is no change in interest rates.

Answer 14

Aggregate demand shifts right by $2.0 trillion

Question 15

In the analysis above, we did not consider the effect of a rising interest rate on consumption spending (or saving as the case may be). If we were to include this effect, how would it change the analysis above?

Answer 15

The rightward shift in aggregate demand would be smaller since people would be consuming less.

Question 16

If an economy appears to be growing rapidly and inflation appears to be becoming a serious problem, which of the following fiscal policies would be appropriate?

Answer 16

A decrease in government spending

Question 17

Suppose the economy has unemployment level close to 15%. A proper fiscal policy might be which of the following:

Answer 17

a decrease in income taxes

Question 18

What will be the effect on the economy if the fiscal policy of reducing transfer payments is selected?

Answer 18

A decrease in disposable income and total spending

Question 19

A temporary income tax cut will be ______________ effective as a fiscal policy than a permanent change because ______________.

Answer 19

less; future income is not affected

Question 20

If we have just experienced a negative supply shock and one is concerned about the current rate of inflation caused by the negative supply shock, then one:

Answer 20

should recommend a tax increase or a policy of doing nothing

Question 21

If total spending increases, tax receipts will ______________. If income tax rates increase, tax receipts will ______________, and total spending will ______________.

Answer 21

increase; increase; decrease

Question 22

If real GDP is equal to the full-employment level of real GDP, an increase in investment spending will mean that either private or public saving will have to ______________ or net exports will have to ______________.

Answer 22

increase; decrease

Question 23

Which of the following statements about budget deficit could be true under different circumstances? Select all that apply.

Answer 23

a
The federal budget deficit may increase at the same time as interest rates fall.
b
The deficit is larger during a recession.
c
The deficit gets larger while inflation increases.

Question 24

An increase in government spending will cause the demand for money to ______________, then interest rates to ______________, which in turn causes investment spending to ______________.

Answer 24

increase; increase; decrease

Question 25

Consider an individual who has secure employment but is concerned about inflation. Suppose that oil prices rise. Which of the following policies would this person be likely to favor?

Answer 25

An increase in taxes and a decrease in government spending

Question 26

Expansionary fiscal policy will cause which of the following?

Answer 26

A rise in interest rates

Question 27

If the President’s goals are to increase the size of government and to solve unemployment problems after a fall in aggregate demand, the President should:

Answer 27

increase government spending

Question 28

Assume the economy is in long-run equilibrium and that the Government decreases taxes to fulfill campaign promises. What happens in the economy in the short run? In the long run?

Answer 28

An increase in real GDP and prices, followed in the long run by decreasing real GDP and increasing prices

Question 29

Assume (1) the deficit would be zero if the economy were at full employment, but (2) the economy currently has a large unemployment rate. Which of the following must be true?

Answer 29

The actual budget must have a deficit.

Question 30

Which of the following is true, if nothing else changes?

Answer 30

If the Federal Reserve decreases the money supply, the federal budget deficit will likely get larger.

Question 31

Given a supply shock that moves the economy from a long-run equilibrium to a new short-run equilibrium at less than full-employment GDP, which of the following policies would be appropriate if the goal was to reduce inflation?

Answer 31

Raise taxes

Question 32

A balanced budget amendment is passed and is made effective in a time when the economy is producing a level of real GDP that is less than the potential. The federal budget is currently in deficit. What should the Federal Reserve do?

Answer 32

Buy bonds

Question 33

Which of the following statements comparing the lags of monetary and fiscal policy is accurate?

Answer 33

The policy-making lag for fiscal policy is longer than monetary policy.

Question 34

Consider the following quote: “Over one and a half million people were laid off from jobs following the doubling of oil prices in 1979.” What was the policy dilemma faced by monetary and fiscal policy makers?

Answer 34

Rising prices and rising unemployment

Question 35

Assume we are currently at full employment. A new administration decides to use fiscal policy to lower unemployment even further and to keep unemployment at the lower level. How does the policy affect the economy in the short and long run?

Answer 35

Short run: Decreased unemployment and increased inflation. Long run: No effect on unemployment and even higher inflation.

Question 36

Once decisions have been made to use monetary policy and fiscal policy to solve a problem, it will take less time for monetary policy to have an effect on real GDP and the price level than would an increase in government spending.

Answer 36

False

Question 37

Assume that we are currently producing less than the potential level of GDP. Which of the following is a valid argument for active use of monetary policy instead of fiscal policy?

Answer 37

Fiscal policy may cause crowding out of investment

Question 38

“An increase in the budget deficit can be beneficial for the economy,” said a member of Congress during the November budget debates. Could this statement be true?

Answer 38

Yes

Question 39

Which of the following accurately refers to “crowding in”?

Answer 39

Increased investment in response to expansionary fiscal policy.

Question 40

It is useful to express the government deficit as a percentage of GDP because this provides a potential indication of the extent of crowding out.

Answer 40

True

Question 41

Which of the following groups would prefer monetary policy to ameliorate a recession, as opposed to fiscal policy?

Answer 41

Borrowers

Question 42

In the long run, expansionary fiscal policy only leads to inflation, and has no other effects on the economy.

Answer 42

False

Question 43

Which of the following fiscal policy actions could the government use to attempt to reverse the shift from question 1.1? Choose all that apply.

Answer 43

a
Increase government spending through a large infrastructure program.
c
Decrease income taxes.
f
Increase transfer payments through Social Security.

Question 44

Suppose the government decides to respond to the stock market crash by changing income taxes. Would their policy be more effective if they changed taxes only over the next year, or if they made a permanent change to taxes? Why?

Answer 44

Permanent tax change. Consumers are less willing to change their spending behavior when they know their future income isn’t affected.

Question 45

Suppose that instead of targeting aggregate demand as in Problem 1.2, the government wanted to increase real GDP by increasing aggregate supply instead. Which of the following actions could the government take to increase aggregate supply? Choose all that apply.

Answer 45

b
Decrease capital gains taxes.
d
Simplify regulations on businesses.
e
Decrease taxes on corporations.

Question 46

If the government did respond to a stock market crash by increasing aggregate supply, which of the following best describes the impact of the policy?

Answer 46

Increasing aggregate supply reverses the impact of the crash on real GDP but exacerbates the change in the price level.

Question 47

The initial headline above means which of the following?

Answer 47

b
The difference between government spending and government tax revenues increased by 39% in the first five months of fiscal 2019.
c
The difference between this year’s tax revenues and spending compared to last year’s budget deficit has increased by 39%.

Question 48

According to the sub-headline, what is the most likely reason for the increased deficit?

Answer 48

Rapid rise in spending and no change in tax revenues means the cause of the increased deficit was the increased spending.

Question 49

Deficits can rise in which of the following circumstances? More than one answer may be correct.

Answer 49

b
An increase in spending alone.
c
A decrease in tax revenues alone.

Question 50

Which of the following could be the consequences of an increased deficit?

Answer 50

More spending in the economy, accompanied by more output and employment.

Question 51

Is a government deficit a bad or good characteristic of an economy?

Answer 51

It depends upon the overall size of the government debt and current conditions in the economy.

Question 52

What happens to a government deficit if private spending in the economy slows its growth?

Answer 52

The deficit will get larger than what it would have otherwise been.

Question 53

Which of the following is most accurate?

Answer 53

Government spending and taxing can be automatic stabilizers.

Explanation

Question 54

What happens to real GDP, employment, and prices if government spending increases? Assume we start in a long-run equilibrium for the economy and go to a new short-run equilibrium. Choose one of the following:

Answer 54

Real GDP rises, employment rises, and prices rise.

Question 55

What happens to real GDP, employment, and prices if income taxes increase? Assume we start in a long-run equilibrium and go to a new short-run equilibrium. Choose one of the following:

Answer 55

Real GDP falls, employment falls, and prices fall.

Question 56

What happens to real GDP, employment, and prices if transfer payments decrease? Assume we start in a long-run equilibrium and go to a new short-run equilibrium. Choose one of the following:

Answer 56

Real GDP falls, employment falls, and prices fall.