1 Chapter 15 Practice Quiz Tutorial Fiscal Policy ©2004 South-Western

2 1. Contractionary fiscal policy is deliberate government action to influence aggregate demand and the level of real GDP through a. expanding and contracting the money supply. b. encouraging business to expand or contract investment. c. regulation of net exports. d. decreasing government spending or increasing taxes. D. The money supply is under control of the Federal Reserve and not Congress.

3 2. The spending multiplier is defined as a. 1 / (1 - marginal propensity to consume). b. 1 / (marginal propensity to consume) c. 1 / (1 - marginal propensity to save). d. 1 / (marginal propensity to consume + marginal propensity to save). A. The spending multiplier is also defined as 1/MPS.

4 3. If the marginal propensity to consume (MPC) is 0.60, the value of the spending multiplier is a. 0.4 b. 0.6 c. 1.5 d D. Spending multiplier = 1 / (1 - MPC) = 1 / ( ) = 1 / 40/100 = 5 / 2 = 2.5

5 4. Assume the economy is in recession and real GDP is below full employment. The marginal propensity to consume (MPC) is 0.80, and the government increases spending by $500 billion. As a result, aggregate demand will rise by a. zero. b. $2,500 billion. c. more than $2,500 billion. d. less than $2,500 billion. B. Change in aggregate demand (  Y) = initial change in government spending (  G) x spending multiplier. Spending multiplier = 1 / (1 - MPC) = 1 / ( ) = 1 / 20/100 = 5  Y = $500 billion x 5  Y = $2,500 billion

6 5. Mathematically, the value of the tax multiplier in terms of the marginal propensity to consume (MPC) is given by the formula a. MPC  1. b. (MPC  1) MPC c. 1 / MPC d. 1  [1 / (1  MPC)]. D. The tax multiplier is also stated as Tax multiplier = 1 - spending multiplier.

7 6. Assume the marginal propensity to consume (MPC) is 0.75 and the government increases taxes by $250 billion. The aggregate demand curve will shift to the a. left by $1,000 billion. b. right by $1,000 billion. c. left by $750 billion. d. right by $750 billion. C. The tax multiplier is -3 (1 - spending multiplier) and -3 times $250 billion equals a $750 billion decrease. The movement is left because consumers have less money to spend.

8 7. If no fiscal policy changes are made, suppose the current aggregate demand curve will increase horizontally by $1,000 billion and cause inflation. If the marginal propensity to consume (MPC) is 0.80, federal policy-makers could follow Keynesian economics and restrain inflation by a. decreasing government spending by $200 billion. b. decreasing taxes by $100 billion. c. decreasing taxes by $1,000 billion. d. decreasing government spending by $1,000 billion. A. Change in government spending (  G) x spending multiplier = change in aggregate demand, rewritten:  G = change in aggregate demand / spending multiplier Spending multiplier = 1 / (1-MPC) = 1 / (1-0.80) = 1 / 20/100 = 5  G = -$1,000/5,  G = -$200 billion.

9 8. If no fiscal policy changes are implemented, suppose the future aggregate demand curve will exceed the current aggregate demand curve by $500 billion at any level of prices. Assuming the marginal propensity to consume (MPC) is 0.80, this increase in aggregate demand could be prevented by a. increasing government spending by $500 billion. b. increasing government spending by $140 billion. c. decreasing taxes by $40 billion. d. increasing taxes by $125 billion. D. Change in taxes (  T) x tax multiplier = change in aggregate demand, rewritten: Tax multiplier = 1 - spending multiplier Spending multiplier = 1 / (1-MPC) = 1 / ) = 1 / 20/100 = 5 Tax multiplier = = -4,  T = $600 billion/5,  T = -$200 billion

10 9. Suppose inflation is a threat because the current aggregate demand curve will increase by $600 billion at any price level. If the marginal propensity to consume (MPC) is 0.75, federal policy-makers could follow Keynesian economics and restrain inflation by a. decreasing taxes by $600 billion. b. decreasing transfer payments by $200 billion. c. increasing taxes by $200 billion. d. increasing government spending by $150 billion. C. 3 x $200 billion = $600 billion.

If no fiscal policy changes are implemented, suppose the aggregate demand curve will shift and exceed the current aggregate demand curve by $900 billion at any level of prices. Assuming the marginal propensity to consume is (MPC) 0.90, this increase in aggregate demand could be prevented by a. increasing government spending by $500 billion. b. increasing government spending by $140 billion. c. decreasing taxes by $40 billion. d. increasing taxes by $100 billion. D. The tax multiplier is 9 (1 - spending multiplier of 10). If taxes are increased by $100 billion spending will go down by $900 billion and aggregate demand shifts leftward by this amount at any price level.

Which of the following is not an automatic stabilizer? a. Defense spending. b. Unemployment compensation benefits. c. Personal income taxes. d. Welfare payments. A. Defense spending does not automatically change levels as real GDP changes.

Supply-side economics is most closely associated with a. Karl Marx. b. John Maynard Keynes. c. Milton Friedman. d. Ronald Reagan. D. The most familiar supply-side economic policy of the Reagan administration was the tax cuts implemented in 1981.

Which of the following statements is true? a. A reduction in tax rates along the downward- sloping portion of the Laffer curve would increase tax revenues. b. According to supply-side fiscal policy, lower tax rates would shift the aggregate demand curve to the right, expanding the economy and creating some inflation. c. The presence of the automatic stabilizers tends to destabilize the economy. d. To combat inflation, Keynesians recommend lower taxes and greater government. A.

15 T max T0 R R max Federal Tax Rate Federal Tax Revenue A The Laffer Curve 100% B C D

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