1. Explain what effect an expansionary fiscal policy would have on the price level and real GDP starting from full employment equilibrium. (4 Marks) 2. Why does a larger government budget deficit...

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1. Explain what effect an expansionary fiscal policy would have on the price level and real GDP starting from full employment equilibrium. (4 Marks)

2. Why does a larger government budget deficit increase the magnitude of the crowding-out effect? (4 Marks)

3. How does the multiplier work and what might government use it for? (5 Marks)

4. Explain what effect a contractionary fiscal policy would have on the price level and real GDP starting from full employment equilibrium. (4 Marks)

5. What are automatic stabilizers and how do they affect the economy? Which is the most important? (5 Marks)

6. Suppose government spending increases in a closed economy. Would the effect on aggregate demand be larger if the Bank of Canada took no action in response, or if the Bank were committed to maintaining a fixed interest rate? Explain (6 Marks)

7. Suppose that a scientific breakthrough leads to the discovery of a new cheap source of energy. What would be the effect of this invention in the short-run and in the long-run? (5 Marks)

8. In which of the following circumstances is expansionary fiscal policy more likely to lead to a short-run increase in investment? Explain (6 Marks)

1. when investment accelerator is large, or when it is small?

2. when the interest sensitivity of investment is large, or when it is small?

3. when the marginal propensity to import is small, or when it is large?

9. For various reasons, fiscal policy changes automatically then output and employment fluctuate. (6 Marks)

1. Explain why tax revenue changes when the economy goes into a recession.

2. Explain why government spending changes when the economy goes into a recession.

3. If the government were to operate under as strict balanced-budget rule, what would it have to do in a recession? Would that make the recession more or less severe?

Multiple Choice Questions - each question is worth 2 Marks

10. Expansionary fiscal policy consists of:

1. increased government purchases, increased taxes, increased transfer payments.

2. decreased government purchases, decreased taxes, decreased transfer payments.

3. increased government purchases, increased taxes, decreased transfer payments.

4. increased government purchases, decreased taxes, increased transfer payments.

11. A sales or excise tax is often considered to be unfair to which group of citizens?

1. no one in particular, because it is a proportional tax that treats everyone the same

2. lower income groups who pay a greater percentage of their income toward the tax than do the wealthy

3. the middle class because they comprise the largest demographic group in society

4. upper income people because they have more income

12. Starting at full employment, if MPC = 2/3, an increase in government purchases of $10 billion would lead AD to ____ and ____ real output in the long run.

1. increase $30 billion; increase

2. increase $30 billion; not change

3. decrease $30 billion; decrease

4. decrease $30 billion; not change

5. None of the above.

13. Refer to Figure A. In order for the economy pictured above to get back to RGDPNR, this economy could use:

1. decreased taxes and increased government purchases.

2. increased taxes and increased government purchases.

3. decreased taxes and decreased government purchases.

4. increased taxes and decreased government purchases.

14. In the short run, expansionary fiscal policy can cause a rise in real GDP:

1. in combination with a rise in the price level.

2. in combination with no rise in the price level.

3. in combination with a reduction in the price level.

4. in combination with a rise or a reduction in the price level, depending on the economy.

15. Starting from long-run equilibrium and a balanced budget, expansionary fiscal policy will tend to:

1. move the federal budget toward surplus and increase net exports.

2. move the federal budget toward surplus and decrease net exports.

3. move the federal budget toward deficit and increase net exports.

4. move the federal budget toward deficit and decrease net exports.

16. If the government wanted to offset the effect of a fall in consumer confidence on AD, it might:

1. decrease government purchases.

2. decrease taxes.

3. decrease transfer payments.

4. do either a) or c).

17. If investment decreases by $20 billion and the MPC = 0.8, the resulting decrease in the consumption component of AD is:

1. $16 billion.

2. $4 billion.

3. $100 billion.

4. $80 billion.

18. To achieve a $50 billion decrease in AD, if the MPC is 0.8, what decrease in government purchases would be called for?

1. $10 billion

2. $40 billion

3. $50 billion

4. $62.5 billion

19. The multiplier effect is based on the fact that ____ by one person is ____to another.

1. income; income

2. expenditures; expenditures

3. expenditures; income

4. income; expenditures

20. If the government wanted to move the economy out of a current recession, which of the following might be an appropriate policy action?

1. decrease taxes

2. increase government purchases of goods and services

3. increase transfer payments

4. any of the above.

21. ____ taxes are designed to take the same percentage of high incomes as compared to lower incomes.

1. Progressive

2. Regressive

3. Proportional

4. Negative

22. If the marginal propensity to consume is 2/3, the multiplier is:

1. 30.

2. 66.

3. 1.5.

4. 3.

23. If the government decides to spend an extra $5 billion on health care that they would otherwise have spent on road construction, and the MPC = 0.75, what is the effect on AD?

1. It has no effect.

2. It increases by $5 billion.

3. It increases by $15 billion.

4. It increases by $20 billion.

24. An increase in transfer payments, combined with a decrease in government purchases, would:

1. increase AD.

2. decrease AD.

3. leave AD unchanged.

4. have an indeterminate effect on AD.

25. Contractionary fiscal policy consists of:

1. increased government purchases, increased taxes, increased transfer payments.

2. decreased government purchases, decreased taxes, decreased transfer payments.

3. decreased government purchases, increased taxes, decreased transfer payments.

4. increased government purchases, decreased taxes, increased transfer payments.

26. The smaller the MPC:

1. the smaller the fraction of an increase in AD due to an increase in government purchases that is consumption.

2. the greater the fraction of an increase in AD due to an increase in government purchases that is consumption.

3. the greater the change in government purchases required to achieve a given change in AD.

4. both a) and c).

5. both b) and c).

27. An increase in government purchases or a decrease in taxes, other things being equal, will tend to:

1. increase interest rates and increase net exports.

2. increase interest rates and decrease net exports.

3. decrease interest rates and increase net exports.

4. decrease interest rates and decrease net exports.

28. If there is initially a federal budget deficit, and government purchases and taxes both rise:

1. AD increases and the budget deficit increases.

2. AD increases and the budget deficit decreases.

3. AD decreases and the budget deficit increases.

4. AD decreases and the budget deficit decreases.

5. there is an indeterminate effect on both AD and the budget deficit.

29. AD will shift to the right, other things being equal, when:

1. the government budget surplus increases because government purchases rose.

2. the government budget surplus increases because taxes fell.

3. the government budget surplus increases because transfer payments rose.

4. under any of the above circumstances.

5. under none of the above circumstances.

30. During a recession, total welfare payments and employment insurance payments automatically increase while income taxes automatically decrease. Which of the following best describes the effect of these changes on aggregate demand?

1. Aggregate demand will be less than it would be without these automatic stabilizers.

2. Aggregate demand will be the same as it was before the recession.

3. Aggregate demand will be more than it would be without these automatic stabilizers.

4. Aggregate demand will be greater than it was before the recession.

31. The primary benefit of the automatic stabilizers is:

1. they provide public assistance through legislative decision making.

2. they require no new legislative action, so there is no legislative lag before these tools respond to fluctuations in the business cycle.

3. they require legislative action, so there is a lag in response to these tools to fluctuations in the business cycle, and there is time to identify the spillover effects.

4. none of the above.

32. The most important automatic stabilizer is:

1. open market operations.

2. the unemployment compensation system.

3. the tax system.

4. the welfare system.

33. One of the real-world complexities of countercyclical fiscal policy is that:

1. fiscal policy is based on forecasts, which are not foolproof.

2. there is a lag between a change in fiscal policy and its effect.

3. there is uncertainty about how much of the multiplier effect will take place in a given amount of time.

4. All of the above are correct.

34. According to the crowding-out effect, if the federal government borrows to finance deficit spending:

1. the demand for loanable funds will decrease, driving interest rates down.

2. the demand for loanable funds will increase, driving interest rates up.

3. the supply of loanable funds will increase, driving interest rates up.

4. the supply of loanable funds will decrease, driving interest rates down.

35. A larger crowding-out effect:

1. increases the magnitude of a given fiscal policy's effect on interest rates and increases the magnitude of its effects on investment.

2. increases the magnitude of a given fiscal policy's effect on interest rates and decreases the magnitude of its effects on investment.

3. decreases the magnitude of a given fiscal policy's effect on interest rates and increases the magnitude of its effects on investment.

4. decreases the magnitude of a given fiscal policy's effect on interest rates and decreases the magnitude of its effects on investment.

36. Due to crowding-out effects, other things being equal:

1. net exports and investment will tend to move in the same direction as a change in government purchases.

2. net exports and investment will tend to move in the opposite direction from a change in government purchases.

3. net exports will tend to move in the same direction as a change in government purchases and investment will tend to move in the opposite direction.

4. net exports will tend to move in the opposite direction as a change in government purchases and investment will tend to move in the same direction.

37. According to the supply-side view of fiscal policy, if the impact on tax revenues is the same, does it make any difference whether the government cuts taxes in a way that reduces marginal tax rates or in a way that does not reduce marginal tax rates?

1. No; both actions will exert the same impact on aggregate supply and demand.

2. Yes; only lower tax rates will increase the incentive to earn marginal income and thereby stimulate aggregate supply.

3. No; in both cases people will increase their saving in the expectation of higher future taxes and thereby offset the stimulus effect of lower taxes.

4. Yes; interest rates will increase if marginal tax rates are lowered, whereas they will tend to decrease if marginal tax rates are left unchanged.

38. According to the Laffer curve:

1. decreasing tax rates on income always increases tax revenues.

2. decreasing tax rates on income always decreases tax revenues.

3. decreasing tax rates are more likely to increase tax revenues, the higher tax rates are to start with.

4. decreasing tax rates are more likely to increase tax revenues, the lower tax rates are to start with.

39. Which group or groups buy Canadian public debt?

1. the Bank of Canada

2. private individuals

3. private institutions

4. all of the above

Answered Same DayDec 20, 2021

Solution

David answered on Dec 20 2021
3 Votes
1. Explain what effect an expansionary fiscal policy would have on the price level and real GDP starting from full employment equili
ium. (4 Marks)
An expansionary fiscal policy includes policy actions like increased government spending or decreased taxes. This action in turn shifts the IS curve and the AD curve to the right by stimulating the domestic economy. This will hence lead to increased price levels. The real GDP will remain the same in the long run at the full employment level.
2. Why does a larger government budget deficit increase the magnitude of the crowding-out effect? (4 Marks)
If the government deficit is large, then the government will have to raise money to fund the deficit. This leads to an increase in the demand for funds and hence pushes up the interest rates. Higher interest rates then in turn crowds out investment to a greater extent as compared to a scenario where there would have been a government budget surplus.
3. How does the multiplier work and what might government use it for? (5 Marks)
The multiplier is the amount by which equili
ium output changes when autonomous aggregate increases by one unit. The change in output is larger than one unit as initial additional amount of spending can lead to increased consumption spending, which in turn increases income further and hence further increases consumption. This process continues resulting in an overall increase in national income greater than the initial incremental amount of spending. Government uses it to navigate the economy through expansionary/contractionary policies which play on this multiple.
3. Explain what effect a contractionary fiscal policy would have on the price level and real GDP starting from full employment equili
ium. (4 Marks)
A contractionary fiscal policy includes policy actions like decreased government spending or increased taxes. This action in turn shifts the IS curve and the AD curve to the left by de-stimulating the domestic economy. This will hence lead to reduced price levels. The real GDP will remain the same in the long run at the full employment level.
6. What are automatic stabilizers and how do they affect the economy? Which is the most important? (5 Marks)
An automatic stabilizer is any mechanism in the conomy that reduces the amount by which output changes in response to a change in autonomous demand. For example: Swings in investment demand will have a smaller effect on output when automatic stabilizers such as proportional income tax , which reduces the multiplier are in place. This means that in the presence of automatic stabilizers we should output to fluctuate less than it would in their absence. Proportional income tax is the most important automatic stabilizer.
4. Suppose government spending increases in a closed economy. Would the effect on aggregate demand be larger if the Bank of Canada took no action in response, or if the Bank were committed to maintaining a fixed interest rate? Explain (6 Marks)
When the government increases spending, then the aggregate spending increases as a result shifting the IS curve to the right. This increases the interest rate. If the government wants to maintain a fixed interest rate, then it will have to shift the LM curve to the right as well. This will
ing down the interest rate but will also further increase the aggregate demand. Hence the aggregate demand is larger if the Bank of Canada were committed to maintaining a fixed interest rate.
5. Suppose that a scientific
eakthrough leads to the discovery of a new cheap source of energy. What would be the effect of this invention in the short-run and in the long-run? (5 Marks)
A new source of energy could have long run impact on the economy. This is because this will increase the industry’s ability of production and raises the supply side potential of the economy at large. Hence, in the short as well as in the long run, this scientific
eakthrough will have a positive impact on the economy.
6. In which of the following circumstances is expansionary fiscal policy more likely to lead to a short-run increase in investment? Explain (6 Marks)
1. when investment accelerator is large, or when it is small? – When the investment accelerator is large
2. when the interest sensitivity of investment is large, or when it is small? – When the interest sensitivity of investment is small.
3. when the marginal propensity to import is small, or when it is large? – When marginal propensity to import is large.
9. For various reasons, fiscal policy changes automatically then output and employment fluctuate. (6 Marks)
1. Explain why tax revenue changes when the economy goes into a recession. – During a recession, the private sector spending reduces and hence, so does income and consumption. Due to reduced demand and hence reduced...
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