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 $$18 trillion and potential real GDP is 19 $$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 tax multiplier?

$$ \text{Tax multiplier} = -\frac{MPC}{1 - MPC} = -\frac{0.8}{1 - 0.8} = -4 $$

Question 1

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

Accepted Answer

A government program that automatically increases spending or decreases taxes in response to economic fluctuations, such as unemployment insurance payments rising during a recession.

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 a likely short-run effect of a large expansionary fiscal policy enacted during a recession, such as the American Recovery and Reinvestment Act of 2009?

Accepted Answer

An increase in real GDP and a reduction in unemployment, but also a larger federal budget deficit.

Question 4

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

Accepted Answer

Aggregate demand decreases, leading to a lower price level than otherwise would have occurred.

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, which reduces private investment and consumption.

Question 6

Suppose real GDP is $$18 trillion and potential real GDP is 19 $$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 NOT a limitation of using fiscal policy to stabilize the economy?

Accepted Answer

Fiscal policy can be implemented instantly without any delays.

Question 8

Which of the following fiscal policy actions is most likely to increase the long-run growth rate of real GDP?

Accepted Answer

A permanent reduction in business taxes to encourage investment.

Question 9

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

Accepted Answer

$$ 	ext{Tax multiplier} = -\frac{MPC}{1 - MPC} = -\frac{0.8}{1 - 0.8} = -4 $$

Question 10

Which of the following statements about the federal budget deficit is correct?

Accepted Answer

A budget deficit occurs when government expenditures exceed tax revenues.

Question 11

During the Covid-19 pandemic, the U.S. government enacted a large expansionary fiscal policy. What was one major cost of this policy?

Accepted Answer

A significant increase in inflation.

Question 12

Which of the following best describes the multiplier effect?

Accepted Answer

A process by which an initial change in autonomous expenditure leads to a larger change in real GDP.

Question 13

If the government increases transfer payments, what is the expected effect on household disposable income and consumption?

Accepted Answer

Household disposable income increases, leading to higher consumption spending.

Question 14

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

Accepted Answer

Congress passes a new law to increase infrastructure spending during a recession.

Question 15

In the long run, what is the effect of an increase in government purchases on real GDP, according to the crowding out effect?

Accepted Answer

No effect on real GDP, as the reduction in private spending offsets the increase in government purchases.

Question 16

Which of the following best explains why estimating the size of fiscal multipliers is difficult?

Accepted Answer

Many factors affect aggregate demand and short-run aggregate supply simultaneously.

Question 17

Which of the following is most likely to be considered a supply-side fiscal policy?

Accepted Answer

A permanent reduction in the corporate income tax rate to encourage investment.

Question 18

If the government wants to use fiscal policy to reduce inflation, which of the following actions should it take?

Accepted Answer

Decrease government purchases or increase taxes.

Question 19

Which of the following is a reason why the Great Depression was more severe than later recessions?

Accepted Answer

Automatic stabilizers like unemployment insurance did not exist.

Question 20

Which of the following best describes the effect of a decrease in tax rates on the multiplier effect?

Accepted Answer

It increases the size of the multiplier effect, since more of any increase in income becomes disposable income.

Fiscal Policy and Its Impact on Economic Growth and Stability

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