Q: Suppose the government increases its purchases by $200 billion, and the marginal propensity to consume (MPC) is 0.8. What is the total change in real GDP, assuming no crowding out and using the simple government spending multiplier formula?

$$ \text{Total change in real GDP} = \frac{1}{1 - 0.8} \times 200 = 1000 \text{ billion} $$

Q: Suppose the government implements a $100 billion tax cut. If the marginal propensity to consume (MPC) is 0.75, what is the total change in real GDP using the tax multiplier formula?

$$ \text{Tax multiplier} = -\frac{0.75}{1 - 0.75} = -3 $$; $$ \text{Total change in real GDP} = -3 \times (-100) = 300 \text{ billion} $$

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 0.8. What is the total change in real GDP, assuming no crowding out and using the simple government spending multiplier formula?

Accepted Answer

$$ 	ext{Total change in real GDP} = \frac{1}{1 - 0.8} 	imes 200 = 1000 	ext{ billion} $$

Question 3

Which of the following is a likely short-run effect of a large expansionary fiscal policy enacted during a recession?

Accepted Answer

An increase in aggregate demand, higher real GDP, and potentially higher inflation.

Question 4

If the government enacts a contractionary fiscal policy when the economy is above potential GDP, what is the expected effect on inflation and real GDP?

Accepted Answer

Inflation will fall and real GDP will decrease.

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 leads to a decrease in private expenditures due to higher interest rates.

Question 6

Suppose the government implements a $100 billion tax cut. If the marginal propensity to consume (MPC) is 0.75, what is the total change in real GDP using the tax multiplier formula?

Accepted Answer

$$ 	ext{Tax multiplier} = -\frac{0.75}{1 - 0.75} = -3 $$; $$ 	ext{Total change in real GDP} = -3 	imes (-100) = 300 	ext{ billion} $$

Question 7

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

Accepted Answer

Immediate and precise effects on aggregate demand.

Question 8

During the 2007-2009 recession, why did many economists believe the recession was especially severe?

Accepted Answer

Because it was caused by a financial crisis, which historically leads to deeper and longer recessions.

Question 9

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

Accepted Answer

A permanent reduction in business taxes to encourage investment.

Question 10

If the government runs a budget deficit, which of the following is true?

Accepted Answer

Government expenditures are greater than tax revenues.

Question 11

Suppose real GDP is $$15 trillion and potential real GDP is 16 $$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

$$ 	ext{Required increase} = \frac{16 - 15}{2} = 0.5 	ext{ trillion} $$

Question 12

Which of the following best describes the multiplier effect?

Accepted Answer

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

Question 13

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 14

If the marginal propensity to consume (MPC) increases, what happens to the size of the government spending multiplier?

Accepted Answer

It increases, because $$ 	ext{Multiplier} = \frac{1}{1 - MPC} .$$

Question 15

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

Accepted Answer

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

Question 16

Which of the following statements about the long-run effects of an increase in government purchases is correct?

Accepted Answer

In the long run, the increase in government purchases will have no effect on real GDP, as private spending is crowded out.

Question 17

Which of the following is most likely to be considered an automatic stabilizer?

Accepted Answer

Unemployment insurance payments that rise during a recession.

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 best describes the relationship between the tax multiplier and the government purchases multiplier?

Accepted Answer

The tax multiplier is smaller in absolute value than the government purchases multiplier.

Fiscal Policy and Economic Growth: Principles of Macroeconomics (ECON 1104)

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