Q: Suppose the government increases its purchases by $200 billion, and the marginal propensity to consume (MPC) is 0.75. What is the total change in real GDP, assuming no crowding out and using the simple government spending multiplier formula?

$$ \text{Total change in real GDP} = \frac{1}{1 - 0.75} \times 200 = 800 \text{ billion} $$

Q: Suppose real GDP is $$18 trillion and potential GDP is 19 $$trillion. If the government wants to close this gap using fiscal policy and the government purchases multiplier is 2, by how much should government purchases increase?

$$ \text{Required increase} = \frac{19 - 18}{2} = 0.5 \text{ trillion} $$

Q: If the marginal propensity to consume (MPC) is 0.8, what is the value of the simple government spending multiplier?

$$ \text{Multiplier} = \frac{1}{1 - 0.8} = 5 $$

Question 1

Which of the following best describes an automatic stabilizer in fiscal policy?

Accepted Answer

A government expenditure or tax that automatically increases or decreases with the business cycle, such as unemployment insurance.

Question 2

Suppose the government increases its purchases by $200 billion, and the marginal propensity to consume (MPC) is 0.75. What is the total change in real GDP, assuming no crowding out and using the simple government spending multiplier formula?

Accepted Answer

$$ 	ext{Total change in real GDP} = \frac{1}{1 - 0.75} 	imes 200 = 800 	ext{ billion} $$

Question 3

Which of the following is an example of discretionary fiscal policy?

Accepted Answer

A reduction in income tax rates passed by Congress in response to a recession.

Question 4

If the government enacts contractionary fiscal policy, what is the expected effect on aggregate demand and the price level in the short run?

Accepted Answer

Aggregate demand decreases, and the price level is lower than it otherwise would have been.

Question 5

Which of the following best explains the concept of 'crowding out' in the context of fiscal policy?

Accepted Answer

An increase in government purchases raises interest rates, reducing private investment and consumption.

Question 6

Suppose real GDP is $$18 trillion and potential GDP is 19 $$trillion. If the government wants to close this gap using fiscal policy and the government purchases multiplier is 2, by how much should government purchases increase?

Accepted Answer

$$ 	ext{Required increase} = \frac{19 - 18}{2} = 0.5 	ext{ trillion} $$

Question 7

Which of the following is a likely long-run effect of persistent budget deficits?

Accepted Answer

An increase in the size of the government sector within the economy.

Question 8

Which of the following would most likely prompt Congress and the president to enact contractionary fiscal policy?

Accepted Answer

A significant increase in the inflation rate.

Question 9

If the marginal propensity to consume (MPC) is 0.8, what is the value of the simple government spending multiplier?

Accepted Answer

$$ 	ext{Multiplier} = \frac{1}{1 - 0.8} = 5 $$

Question 10

Which of the following statements about the multiplier effect is correct?

Accepted Answer

The multiplier effect means that an initial change in autonomous expenditure leads to a larger change in real GDP.

Question 11

Which of the following is NOT a limitation of using fiscal policy to stabilize the economy?

Accepted Answer

Fiscal policy can be implemented instantly without delays.

Question 12

Which of the following best describes the effect of a permanent cut in business taxes on long-run economic growth?

Accepted Answer

It is likely to increase the growth rate of real GDP by encouraging investment and productivity.

Question 13

Suppose the government increases transfer payments by $50 billion. If the marginal propensity to consume (MPC) is 0.6, what is the initial increase in consumption spending, and what is the total change in real GDP?

Accepted Answer

Initial increase: $$30 billion; Total change: $$ \frac{1}{1 - 0.6} 	imes 30 = 75 	ext{ billion} $

Question 14

Which of the following is true regarding the tax multiplier?

Accepted Answer

The tax multiplier is negative because an increase in taxes decreases equilibrium real GDP.

Question 15

During the 2007-2009 recession, why did economists Carmen Reinhart and Kenneth Rogoff find the recession especially severe?

Accepted Answer

Because recessions following financial crises tend to be deeper and longer-lasting.

Question 16

Which of the following is a supply-side fiscal policy intended to increase long-run potential GDP?

Accepted Answer

Reducing marginal tax rates to increase incentives to work and invest.

Question 17

If the government runs a budget deficit, how does it finance the deficit?

Accepted Answer

By issuing government bonds and borrowing from the public.

Question 18

Which of the following best describes the effect of automatic stabilizers during a recession?

Accepted Answer

They increase government spending and decrease tax revenues, helping to limit the severity of the recession.

Question 19

Which of the following is the correct formula for the growth rate of real GDP, according to the study materials?

Accepted Answer

$$ 	ext{Growth rate of real GDP} = 	ext{Growth rate of hours worked} + 	ext{Growth rate of labor productivity} $$

Fiscal Policy and Its Impact on Economic Growth and Stability

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