Question 1

According to the crowding-out effect, what is the primary reason that an increase in government borrowing may fail to increase aggregate demand in a closed economy?

Accepted Answer

Because increased government borrowing raises interest rates, which reduces private investment and consumption.

Question 2

In an open economy, what is a likely consequence of higher government deficits according to the crowding-out model?

Accepted Answer

An appreciation of the domestic currency and a decrease in net exports.

Question 3

Which of the following best describes the New Classical view of fiscal policy?

Accepted Answer

Deficits are offset by increased private saving in anticipation of future taxes, leaving aggregate demand unchanged.

Question 4

Suppose the government increases its budget deficit by $100 billion. According to the crowding-out effect, what happens in the loanable funds market?

Accepted Answer

The demand for loanable funds shifts right, increasing the real interest rate.

Question 5

Which equation best represents the relationship between government spending ($$G$$), taxes ($$T$$), and the budget deficit ($$D$$)?

Accepted Answer

$$ D = G - T $$

Question 6

If the marginal tax rate is reduced, what is the expected supply-side effect according to supply-side economics?

Accepted Answer

An increase in the incentive to work and invest, shifting SRAS and LRAS to the right.

Question 7

Which of the following is a secondary effect of expansionary fiscal policy in an open economy?

Accepted Answer

An appreciation of the domestic currency, reducing net exports.

Question 8

According to public choice analysis, why are budget deficits more common than surpluses?

Accepted Answer

Legislators are incentivized to spend on their constituents but reluctant to raise taxes.

Question 9

If the government cuts taxes and finances the resulting deficit by borrowing, what is a possible short-run effect according to supply-side economics?

Accepted Answer

Aggregate demand increases, but if supply does not increase as much, the price level may rise.

Question 10

Which of the following best explains why the share of taxes paid by the top 0.5% of earners increased even as their marginal tax rates declined?

Accepted Answer

Lower marginal tax rates increased incentives to earn more income, resulting in higher taxable income.

Question 11

Which of the following is a key criticism of Keynesian fiscal policy from the perspective of modern economists?

Accepted Answer

It ignores the incentive effects of fiscal changes and secondary effects such as crowding out.

Question 12

Suppose the government increases spending by $100 billion, but the real interest rate rises as a result. What is the likely effect on private investment and aggregate demand?

Accepted Answer

Private investment decreases, offsetting the increase in aggregate demand.

Question 13

Which of the following equations represents the equilibrium in the loanable funds market when the government runs a deficit and households fully anticipate future taxes (New Classical view)?

Accepted Answer

$$ S_2 = I_2 + 	ext{Government Borrowing} $$

Question 14

During the 1990s, what was the general trend in U.S. federal spending as a share of GDP and the federal budget balance?

Accepted Answer

Federal spending as a share of GDP fell modestly and the budget moved toward surplus.

Question 15

If the government increases its budget deficit in an open economy, which sequence of events is most likely according to the crowding-out effect?

Accepted Answer

Higher deficit → higher interest rates → capital inflow → currency appreciation → lower net exports.

Question 16

Which of the following statements is consistent with the New Classical view of fiscal policy?

Accepted Answer

Fiscal deficits are offset by increased private saving, leaving aggregate demand and output unchanged.

Question 17

Which of the following best describes the supply-side effect of a reduction in marginal tax rates?

Accepted Answer

It increases the incentive to work and invest, causing a rightward shift in SRAS and LRAS.

Fiscal Policy, Incentives, and Secondary Effects: An Advanced Macroeconomics Study Guide

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