Q: Suppose the marginal propensity to consume (MPC) is 0.8 and the tax rate is 0.25. What is the government purchases multiplier?

$$\frac{1}{1 - MPC \times (1 - t)} = \frac{1}{1 - 0.8 \times 0.75} = \frac{1}{1 - 0.6} = \frac{1}{0.4} = 2.5$$

Question 1

Which of the following best describes discretionary fiscal policy?

Accepted Answer

Intentional actions by the government to change spending or taxes to achieve macroeconomic objectives.

Question 2

Suppose the government increases its purchases by $100 billion and the marginal propensity to consume (MPC) is 0.75. What is the total increase in real GDP, assuming no taxes and no imports?

Accepted Answer

$400 billion

Question 3

Which formula correctly represents the government purchases multiplier in a simple closed economy with no taxes or imports?

Accepted Answer

$$\frac{1}{1 - MPC}$$

Question 4

If the government wants to reduce inflation that is above its target, which fiscal policy should it enact?

Accepted Answer

Decrease government purchases and/or increase taxes.

Question 5

Which of the following is an example of an automatic stabilizer?

Accepted Answer

Unemployment insurance payments increasing during a recession.

Question 6

In the dynamic aggregate demand and aggregate supply model, what is a likely effect of expansionary fiscal policy?

Accepted Answer

Real GDP increases and the price level rises compared to no policy action.

Question 7

Which of the following best explains why the tax multiplier is smaller in absolute value than the government purchases multiplier?

Accepted Answer

A portion of a tax cut is saved rather than spent, reducing its impact on aggregate demand.

Question 8

Suppose the marginal propensity to consume (MPC) is 0.8 and the tax rate is 0.25. What is the government purchases multiplier?

Accepted Answer

$$\frac{1}{1 - MPC 	imes (1 - t)} = \frac{1}{1 - 0.8 	imes 0.75} = \frac{1}{1 - 0.6} = \frac{1}{0.4} = 2.5$$

Question 9

Which of the following is a potential long-run consequence of persistent government budget deficits?

Accepted Answer

Crowding out of private investment, potentially reducing long-term economic growth.

Question 10

If the government increases both spending and taxes by $10 billion, what is the short-run effect on real GDP according to the balanced budget multiplier?

Accepted Answer

Real GDP increases by $10 billion.

Question 11

Which of the following is NOT a reason why fiscal policy may be less effective than monetary policy for stabilizing the economy?

Accepted Answer

Immediate effect on aggregate demand.

Question 12

What is the main difference between a budget deficit and government debt?

Accepted Answer

A budget deficit is the annual shortfall when expenditures exceed tax revenue; government debt is the accumulation of past deficits.

Question 13

Which of the following policies is most likely to increase long-run economic growth according to supply-side economics?

Accepted Answer

Reducing tax wedges to increase incentives to work, save, and invest.

Question 14

If the marginal propensity to import (MPI) increases, what happens to the government purchases multiplier in an open economy?

Accepted Answer

It decreases because more spending leaks out to imports.

Question 15

Which equation best represents the tax multiplier in a simple model with no imports or transfer payments?

Accepted Answer

$$\frac{-MPC}{1 - MPC}$$

Question 16

During a recession, why do automatic stabilizers help reduce the severity of economic downturns?

Accepted Answer

They increase government spending and reduce tax revenue automatically, supporting aggregate demand.

Question 17

Which of the following is a plausible effect of crowding out in the short run?

Accepted Answer

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

Question 18

If the marginal propensity to consume (MPC) is 0.75, what is the tax multiplier?

Accepted Answer

$$\frac{-0.75}{1 - 0.75} = -3$$

Question 19

Which of the following is NOT a component of federal government expenditures?

Accepted Answer

Corporate profits taxes.

Question 20

Which of the following statements about the effectiveness of the 2009 stimulus package is supported by the Congressional Budget Office (CBO)?

Accepted Answer

The stimulus package reduced the severity of the recession but did not fully restore full employment.

Chapter 16: Fiscal Policy – Study Notes for Macroeconomics

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