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Chapter 11: Fiscal Policy

Chapter 11: Fiscal Policy


Multiple Choice Questions
1. According to Keynes, the level of economic activity is predominantly determined by the level of:
A) Aggregate supply. B) Aggregate demand. C) Unemployment. D) Interest rates.
Answer: B Type: Basic Understanding Page: 218

2. According to Keynesian theory, which of the following should be used to increase aggregate demand?
A) Market self-adjustment.
C) An increase in government expenditure.
B) A tax increase.
D) An increase in interest rates.
Answer: C Type: Complex Understanding Page: 218

3. Keynesians would recommend:


A) Higher taxes when there is excess aggregate demand.
B) Higher government expenditures when there is a shortfall in aggregate demand.
C) Reliance on government rather than the market for adjustment when an undesirable level of aggregate
demand occurs.
D) All of the above.
Answer: D Type: Complex Understanding Page: 218

TAXES AND SPENDING


4. Which of the following gave the U.S. federal government the power to tax income?
A) The Sixteenth Amendment to the Constitution.
B) The Full Employment and Balanced Growth Act of 1978.
C) The Social Security Act.
D) The capital gains tax of the Bush administration.
Answer: A Type: Basic Understanding Page: 218

5. Which of the following is an income transfer?


A) Free medical care made available to the poor by a private physician.
B) Unemployment benefits paid to a factory worker who was laid off.
C) A new highway built by the federal government.
D) All of the above.
Answer: B Type: Basic Understanding Page: 218

6. The use of government taxes and spending to alter economic outcomes is known as:
A) Monetary policy. B) Fiscal policy. C) Income policy. D) Foreign-trade policy.
Answer: B Type: Definition Page: 219

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Chapter 11: Fiscal Policy

7. Fiscal policy is:


A) An internal market force.
B) A macroeconomic outcome.
C) The use of budget levers to influence the macroeconomy.
D) All of the above.
Answer: C Type: Definition Page: 219

8. Fiscal policy levers include:


A) Taxes. B) Government spending.

C) Income transfers.

D) All of the above.

Answer: D Type: Definition Page: 219

9. Fiscal policy works primarily through:


A) Shifts of the AS curve.
B) Shifts of the AD curve.
C) The improvement of worker skills through subsidized training programs.
D) Shifts of both AD and AS as a result of changes in the interest rate.
Answer: B Type: Basic Understanding Page: 219

10. Which of the following fiscal policies would cause a decrease in aggregate expenditures?
A) An increase in transfer payments and an increase in government spending.
B) An increase in transfer payments and a decrease in taxes.
C) A decrease in taxes and an increase in government spending.
D) An increase in taxes and a decrease in government spending
Answer: D Type: Complex Understanding Page: 219

11. Which of the following would cause both an increase in the price level and an increase in real output?
A) A tax hike.
C) A decrease in production costs.
B) An increase in transfer payments.
D) All of the above.
Answer: B Type: Complex Understanding Page: 219

12. Which of the following government actions is an example of fiscal policy?


A) Decreasing corporate income tax rates.
B) Purchasing fighter planes from a U.S. manufacturer.
C) Increasing social security tax rates.
D) All of the above.
Answer: D Type: Complex Understanding Page: 219

13. Which of the following is generally considered a desirable outcome of fiscal policy?
A) More jobs. B) A higher price level. C) Higher unemployment rates. D) Greater deficits.
Answer: A Type: Basic Understanding Page: 219

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Chapter 11: Fiscal Policy

FISCAL STIMULUS
14. Fiscal policy options to stimulate the economy include:
A) An increase in transfer payments.
B) An increase in taxes.
C) A decrease in government spending on goods and services.
D) All of the above.
Answer: A Type: Basic Understanding Page: 220

15. Assume the economy is operating below full employment. Which of the following policy actions will allow
aggregate spending to increase but will not increase the size of the government in the process?
A) Increase government spending and leave tax rates unchanged.
B) Decrease tax rates and leave government spending unchanged.
C) Increase government spending and taxes by the same amount.
D) Decrease government spending by more than an increase in taxes.
Answer: B Type: Basic Understanding Page: 220

16. Which of the following is a fiscal policy tool used to stimulate the economy?
A) Higher interest rates.
C) Reducing inefficient employment of resources.
B) Increased imports.
D) Increased government purchases.
Answer: D Type: Basic Understanding Page: 220

17. Which of the following will provide fiscal stimulus to the economy?
A) Decreasing taxes.
B) Increasing government spending on goods and services.
C) Increasing transfer payments.
D) All of the above.
Answer: D Type: Basic Understanding Page: 220

18. Which of the following will cause an increase in aggregate demand?


A) Increasing purchases of goods and services.
C) Raising income transfers.
B) Reducing taxes.
D) All of the above.
Answer: D Type: Basic Understanding Page: 220

19. In Keynesian theory, at macro equilibrium:


A) The economy may or may not be at full employment.
B) Aggregate demand intersects aggregate supply.
C) The economy will stay at that output level, ceteris paribus.
D) All of the above.
Answer: D Type: Definition Page: 220

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20. In a diagram of aggregate demand and supply curves, the GDP gap is measured as the:
A) Horizontal distance between the equilibrium output and the full-employment output.
B) Vertical distance between the equilibrium price and the price at which the aggregate demand would
intersect aggregate supply at full employment.
C) Horizontal distance between the aggregate demand necessary to achieve full employment and the
aggregate demand curve at equilibrium output.
D) Vertical distance between the equilibrium output and the full-employment output.
Answer: A Type: Analytical Page: 220

21. The GDP gap will differ from the AD shortfall when the:
A) Multiplier effect raises spending.
C) Budget is balanced.
B) Aggregate supply curve slopes upward.
D) All of the above.
Answer: B Type: Basic Understanding Page: 220

22. The GDP gap differs from the AD shortfall when:


A) The aggregate supply curve slopes upward.
B) The multiplier effect raises spending.
C) The AS curve is horizontal.
D) There is a time lag in the implementation of fiscal policy.
Answer: A Type: Basic Understanding Page: 220

23. The "nave" Keynesian model is unrealistic because it:


A) Does not take into account probable changes in the price level as the economy approaches full
employment.
B) Assumes that the price level decreases as AD increases.
C) Assumes that AS is upward sloping when it is more probably horizontal.
D) Does not account for changes in output due to the multiplier.
Answer: A Type: Complex Understanding Page: 220

24. In a diagram of aggregate demand and supply curves, the AD shortfall is measured as the:
A) Vertical distance between the equilibrium price and the price at which the aggregate demand would
intersect aggregate supply at full employment.
B) Horizontal distance between the equilibrium output and the full-employment output.
C) Horizontal distance between the aggregate demand curve necessary for full employment and the
aggregate demand curve at the equilibrium price.
D) All of the above.
Answer: C Type: Analytical Page: 221

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Chapter 11: Fiscal Policy


25.
A)
B)
C)
D)

The amount of additional income generated by increased government spending depends on the:
Marginal propensity to consume.
Number of spending cycles that occur in a given period of time.
Size of the multiplier.
All of the above.

Answer: D Type: Analytical Page: 221

26. Ceteris paribus, if income was transferred from individuals with a low MPC to those with a high MPC,
aggregate demand would:
A) Increase. B) Decrease. C) Stay the same. D) Increase or decrease, but not because of the MPC.
Answer: A Type: Complex Understanding Page: 222

27. Which of the following is true when the government attempts to move the economy to full employment by
increasing spending?
A) The desired stimulus should be set by the AD short fall multiplied by the multiplier.
B) It must initially spend more than the GDP gap if the aggregate supply curve is upward-sloping.
C) The total change in spending includes both the new government spending and the subsequent increases
in consumer spending.
D) All of the above.
Answer: C Type: Complex Understanding Page: 222

28. Suppose the consumption function is C = 100 + 0.90Y. If the government stimulates the economy with
$100 billion in increased government purchases, aggregate expenditure would rise by:
A) $10 billion. B) $900 billion. C) $1,000 billion. D) $800 billion.
Answer: C Type: Analytical Page: 222

29. Suppose the consumption function is C = 200 + 0.60Y. If the government stimulates the economy with
$100 billion in increased government purchases, aggregate expenditure would rise by:
A) $250 billion. B) $600 billion. C) $800 billion. D) $450 billion.
Answer: A Type: Analytical Page: 222

30. If the multiplier is 5 and a change in fiscal policy leads to a $500 million decrease in total spending, we can
conclude that:
A) Government spending decreased by $500 million.
B) Taxes increased by $500 million.
C) Taxes decreased by $100 million.
D) Government spending decreased by $100 million.
Answer: D Type: Analytical Page: 222

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31.
If the multiplier is 4 and a change in government spending leads to a $500 million decrease in
aggregate demand, we can conclude that:
A) Government spending decreased by $125 million.
B) Taxes increased by $500 million.
C) Taxes decreased by $100 million.
D) Government spending decreased by $100 million.
Answer: A Type: Complex Understanding Page: 222

32. Assume the MPC is 0.80. The change in total spending for the economy because of a $200 billion
government spending increase is:
A) $160 billion. B) $200 billion. C) $800 billion. D) $1,000 billion.
Answer: D Type: Analytical Page: 222

33. Assume the MPC is 0.75. The change in total spending for the economy because of a $150 billion
government spending increase is:
A) $75 billion. B) $150 billion. C) $600 billion. D) $750 billion.
Answer: C Type: Analytical Page: 222

34. To eliminate an AD shortfall of $100 billion when the economy has an MPC of 0.50, the government
should increase spending by:
A) $200 billion. B) $100 billion. C) $50 billion. D) $500 billion.
Answer: C Type: Analytical Page: 223

35. To eliminate an AD shortfall of $120 billion when the economy has an MPC of 0.75, the government
should decrease taxes by:
A) $400 billion. B) $120 billion. C) $30 billion. D) $40 billion.
Answer: D Type: Analytical Page: 224

36. To eliminate an AD shortfall of $100 billion when the economy has an MPC of 0.80, the government
should increase transfer payments by:
A) $25 billion. B) $100 billion. C) $80 billion. D) $20 billion.
Answer: A Type: Analytical Page: 224

37. If the desired fiscal stimulus is $20 billion and the desired AD increase is $50 billion, we can conclude that:
A) The MPS is 0.60.
C) The multiplier is 2.0.
B) There is an inflationary gap.
D) The MPC is 0.60.
Answer: D Type: Complex Understanding Page: 223

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Chapter 11: Fiscal Policy


38.
With an upward-sloping aggregate supply curve, real output can be increased to the fullemployment output level if:
A) Government expenditures are increased by the amount of the GDP gap.
B) Government expenditures are increased by the amount of the AD shortfall.
C) Aggregate demand is increased by the amount of the GDP gap.
D) Government expenditures are increased by the amount of the AD shortfall divided by the multiplier.
Answer: D Type: Analytical Page: 223

39. The AD shortfall divided by the multiplier is equal to:


A) The MPC.
B) Desired fiscal stimulus.
C) Total gain in income generated from lower spending.
D) First-round consumption that is lost from higher taxes.
Answer: B Type: Basic Understanding Page: 223

40. Which of the following explains why the government should not increase spending by the entire amount of
the AD shortfall to move the economy to full employment?
A) Price level changes will make up for the difference between the fiscal stimulus and the AD shortfall .
B) The multiplier process will contribute to an additional increase in aggregate demand.
C) The government can increase taxes to create an additional increase in aggregate demand.
D) All of the above.
Answer: B Type: Basic Understanding Page: 223

41. Given a $600 billion AD shortfall and an MPC of 0.50, the desired fiscal stimulus would be:
A) A $1200 billion increase in government expenditures.
B) A $600 billion increase in government expenditures.
C) A $300 billion increase in government expenditures.
D) A $200 billion increase in government expenditures.
Answer: C Type: Basic Understanding Page: 223

42. Given a $500 billion AD shortfall and an MPC of 0.75, the desired fiscal stimulus would be:
A) A $2 trillion increase in government expenditures.
B) A $375 billion increase in government expenditures.
C) A $500 billion increase in government expenditures.
D) A $125 billion increase in government expenditures.
Answer: D Type: Basic Understanding Page: 223

43. Which of the following is the best choice if the desired fiscal stimulus is $10 billion and the desired AD
increase is $100 billion?
A) Tax hike is $11.11 billion.
C) Tax cut is $11.11 billion.
B) Tax hike is $10 billion.
D) Tax cut is $10 billion.
Answer: C Type: Complex Understanding Page: 224

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44. The fiscal stimulus associated with a tax cut is:
A) The same as the stimulus associated with an increase in transfer payments.
B) The same as the stimulus associated with a decrease in transfer payments.
C) Less than the stimulus associated with an increase in transfer payments.
D) Greater than the stimulus associated with an increase in government spending.
Answer: A Type: Complex Understanding Page: 224

45. If the MPC equals 0.80, $200 billion tax decrease will increase consumption in the first round by:
A) $40 billion. B) $160 billion. C) $200 billion. D) $1000 billion.
Answer: B Type: Analytical Page: 224

46. Which of the following equals the initial, or first-round, increase in consumption because of a tax cut?
A) MPC tax cut. B) MPC multiplier x tax cut. C) Tax cut MPS. D) Multiplier tax cut.
Answer: A Type: Analytical Page: 224

47. The desired tax cut to close a GDP gap is given by:
A) AD shortfall MPS.
B) AD shortfall MPC.

C) Desired fiscal stimulus MPC.


D) Desired fiscal stimulus MPC.

Answer: C Type: Basic Understanding Page: 224

48. A tax cut has less impact on aggregate demand than an increase in government purchases of the same size
because:
A) A portion of the tax cut is invested.
C) Tax cuts do not increase disposable income.
B) A portion of the tax cut is saved.
D) The tax-cut multiplier is equal to 1.
Answer: B Type: Basic Understanding Page: 224

49. A tax cut:


A) Directly increases the disposable income of consumers.
B) Contains less fiscal stimulus than an increase in government spending of the same size.
C) Shifts the AD curve to the right.
D) All of the above.
Answer: D Type: Basic Understanding Page: 224

50. An MPS of 0.25 means a $50 million tax cut ultimately:


A) Reduces spending by $50 million.
C) Increases spending by $400 million.
B) Increases spending by $200 million.
D) Increases spending by $150 million.
Answer: D Type: Analytical Page: 224

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51. What happens to aggregate demand when government spending and the taxes to pay for it both rise by the
same amount?
A) Aggregate demand falls by the amount of the government spending.
B) There is no effect.
C) Aggregate demand rises by the amount of the government spending.
D) Aggregate demand rises by the amount of the government spending times the multiplier.
Answer: C Type: Complex Understanding Page: 227

52. If the government increases spending and maintains a balanced budget at the same time:
A) There will be no effect on the economy, since taxes balance government spending.
B) Income will increase by the amount of the increase in government spending.
C) Income will increases through the multiplier effect by more than the increase in government spending.
D) Income will actually decrease by the amount that taxes have to be increased to offset the effects of the
government spending.
Answer: B Type: Basic Understanding Page: 227

53. If the government cuts taxes by $200 million and simultaneously decreases government purchases by $200
million, then:
A) Income will rise because the government decrease in purchases occurs so slowly.
B) Income in the economy will remain unchanged.
C) People will spend only a part of their tax cut, so income will eventually fall by $200 million.
D) Income will decrease by $200 million times the multiplier.
Answer: C Type: Complex Understanding Page: 227

54. Assume the MPC is 0.75, taxes increase by $100 billion, and government spending increases by $100
billion. Aggregate demand will:
A) Increase by $400 billion.
C) Increase by $100 billion.
B) Decrease by $400 billion.
D) Not change.
Answer: C Type: Complex Understanding Page: 227

55. Suppose the government decides to increase taxes by $50 billion and to increase transfer payments by $50
billion. What effect would there be on aggregate demand?
A) Zero.
B) $50 billion increase.
C) More than $50 billion increase after the multiplier effect.
D) $50 billion decrease.
Answer: A Type: Analytical Page: 227

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56.
Suppose the government decides to increase taxes by $20 billion in order to increase social
security benefits by the same amount. If prices remain at current levels, this combined tax-transfer policy will:
A) Leave aggregate demand unchanged.
B) Increase aggregate demand by $20 billion.
C) Increase aggregate demand by more than $20 billion after all multiplying effects.
D) Decrease aggregate demand by $20 billion.
Answer: A Type: Complex Understanding Page: 227

57. Suppose the consumption function is C = 100 + 0.80 Y. If the government stimulates the economy with
$200 billion in increased income transfers, aggregate expenditure would rise by:
A) $200 billion. B) $400 billion. C) $800 billion. D) $1,000 billion.
Answer: C Type: Analytical Page: 227

58. Which of the following would cause the level of income to change by the greatest amount, ceteris paribus?
A) An increase in social security payments of $10 billion.
B) A reduction in personal income taxes of $10 billion.
C) An increase in defense spending of $10 billion.
D) The changes suggested above have equal impacts on the level of income.
Answer: C Type: Complex Understanding Page: 227

59. Which of the following is most powerful in shifting the aggregate spending curve to the right?
A) A $1 reduction in taxes.
C) A $1 increase in government purchases.
B) A $1 increase in transfer payments.
D) All are equally powerful.
Answer: C Type: Complex Understanding Page: 227

60. For a given amount of desired stimulus, dollar for dollar:


A) Government spending is more effective than tax cuts.
B) Tax cuts are more effective than income transfers.
C) Income transfers are more effective than tax cuts.
D) Income transfers are more effective than government spending.
Answer: A Type: Basic Understanding Page: 227

FISCAL RESTRAINT
61. Aggregate demand shifts to the left when:
A) Government taxes are increased.
B) Government transfers are decreased.

C) Government purchases are decreased.


D) All of the above.

Answer: D Type: Analytical Page: 228

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62.
When the macro equilibrium is above full employment, fiscal policy should be used to shift
aggregate demand by the amount of:
A) The difference between saving and investment.
B) The difference between desired saving and desired investment.
C) The AD excess.
D) None of the above because aggregate supply is the curve that must be shifted.
Answer: C Type: Analytical Page: 228

63. When there is excess aggregate demand in the economy:


A) Unemployment is higher than at full employment.
B) The GDP gap is negative.
C) Aggregate supply must be shifted leftward.
D) All of the above.
Answer: B Type: Basic Understanding Page: 229

64. Which of the following is equal to the AD excess divided by the multiplier?
A) The desired fiscal restraint.
B) The MPC.
C) The first-round consumption increase.
D) The cumulative change in income because of a spending change.
Answer: A Type: Analytical Page: 229

65. The desired fiscal restraint is equal to:


A) Excess AD times the multiplier.
B) Desired AD reduction.

C) Excess AD divided by the multiplier.


D) GDP gap divided by the multiplier.

Answer: C Type: Basic Understanding Page: 229

66. When there is excess aggregate demand in the economy:


A) Desired fiscal restraint equals the AD excess divided by the multiplier.
B) The GDP gap is negative.
C) Full-employment output is lower than equilibrium output.
D) All of the above.
Answer: D Type: Basic Understanding Page: 229

67. If the desired fiscal restraint is $80 billion and the AD excess is $160 billion, we can conclude that:
A) The MPS is 0.50.
C) The multiplier is 0.50.
B) There is a recessionary gap.
D) The MPC is 2.0.
Answer: A Type: Complex Understanding Page: 229

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68.
If the MPC for an economy is 0.90, a $4 billion increase in taxes will ultimately cause
consumption to decrease by:
A) $40 million. B) $36 million. C) $4.4 million. D) $3.6 million.
Answer: B Type: Complex Understanding Page: 231

69. If the MPC for an economy is 0.90, a $4 billion increase in taxes will ultimately cause consumption to
decrease by:
A) $40 million. B) $36 million. C) $4.4 million. D) $3.6 million.
Answer: B Type: Complex Understanding Page: 231

70. If the MPC for an economy is 0.80, a $2 billion increase in taxes will ultimately cause consumption to
decrease by:
A) $4 million. B) $10 million. C) $8 million. D) $2 million.
Answer: C Type: Complex Understanding Page: 231

71. If the MPC equals 0.75, $100 billion tax increase will decrease consumption in the first round by:
A) $100 billion. B) $300 billion. C) $400 billion. D) $75 billion.
Answer: D Type: Analytical Page: 231

72. If the MPC equals 0.75, a $100 billion transfer payment decrease will decrease consumption in the first
round by:
A) $25 billion. B) $75 billion. C) $100 billion. D) $400 billion.
Answer: B Type: Analytical Page: 231

73. An MPC of 0.80 means a $100 million transfer payment decrease:


A) Reduces consumption in the first round by $80 million.
B) Reduces consumption in the first round by $20 million.
C) Increases consumption in the first round by $20 million.
D) Increases consumption in the first round by $80 million.
Answer: A Type: Analytical Page: 231

74. If the MPC is 0.75, a $200 million transfer payment decrease ultimately:
A) Reduces spending by $150 million.
C) Increases spending by $600 million.
B) Reduces spending by $600 million.
D) Increases spending by $150 million.
Answer: B Type: Analytical Page: 231

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75.
Assume the economy is at full employment and prices are reasonably stable. If the government
wants to increase spending for public schools, which of the following policies will have the least inflationary
impact?
A) An increase in taxes by an amount greater than the increase in spending.
B) An increase in taxes by an amount smaller than the increase in spending.
C) An increase in taxes equal to the increase in spending.
D) No change in taxes when expenditures increase.
Answer: A Type: Complex Understanding Page: 231

FISCAL GUIDELINES
76. Crowding out occurs when the government:
A) Increases taxes, thus causing a decrease in consumption.
B) Issues debt, thus making it more difficult for the private sector to issue debt.
C) Prints money, which displaces currency.
D) Does all of the above.
Answer: B Type: Basic Understanding Page: 232

77. Ceteris paribus, which of the following is true about the concept of crowding out?
A) It increases the private sector's ability to raise the level of output.
B) It does not affect the private sector's ability to raise the level of output.
C) It reduces the private sector's ability to raise the level of output.
D) It occurs when spending increases are matched with tax increases.
Answer: C Type: Definition Page: 232

78. The crowding out effect refers to:


A) A decrease in consumption or investment as a result of an increase in government borrowing.
B) A decrease in investment resulting from an increase in consumption and a decrease in savings.
C) A decrease in government spending resulting from a decrease in taxes.
D) A decrease in consumption resulting from an increase in investment.
Answer: A Type: Definition Page: 232

79. Which of the following are likely to limit the effectiveness of fiscal policy in the real world?
A) The crowding out effect.
B) Time lags between the recognition of a macro problem and the implementation of corrective measures.
C) Political considerations which could alter the content and timing of fiscal policy.
D) All of the above.
Answer: D Type: Basic Understanding Page: 232

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80.
A)
B)
C)
D)

Time lags limit the effectiveness of fiscal policy because in the real world it takes time:
To recognize and measure macroeconomic problems.
To develop an appropriate corrective fiscal policy.
For the multiplier process to occur.
All of the above.

Answer: D Type: Basic Understanding Page: 232

81. Suppose economic conditions call for a tax increase but Congress does not implement this measure because
an election is approaching. This is an example of which of the real world problems associated with fiscal
policy?
A) Pork-barrel politics. B) Time lags. C) Crowding out. D) All of the above.
Answer: A Type: Basic Understanding Page: 233

THE ECONOMY TOMORROW


82. When Joan Robinson is quoted in the text saying "Keynes did not want anyone to dig holes and fill them,"
she is pointing out that:
A) The content of fiscal policy is as important as its aggregate impact on the economy.
B) The government should not be interfering in the economy because the jobs created are usually
unproductive.
C) As far as stabilization objectives are concerned, the level of spending is the only thing that counts.
D) Keynesian economic policies do not work.
Answer: A Type: Complex Understanding Page: 233

83. The second crisis of economic theory refers to:


A) The typical fiscal policy tradeoff between unemployment and inflation.
B) The dominance of Keynesian views in fiscal policy to the exclusion of newer, more enlightened
viewpoints.
C) An emphasis on the level of output without concern for the content of output in terms of fiscal policy.
D) Our inability to maintain full employment output over any significant period of time.
Answer: C Type: Basic Understanding Page: 233

84. Fiscal policy affects:


A) The level of output only.
B) The mix of output only.
C) Both the level and the mix of output.
D) Interest rates only and therefore does not affect the level or mix of output.
Answer: C Type: Basic Understanding Page: 233

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Use the following to answer questions 85-90:
Figure 11.1

85. Refer to Figure 11.1. Assume aggregate demand is represented by AD1 and full employment is $6.0
trillion. The economy confronts a real GDP gap of:
A) $200 billion. B) $400 billion. C) $200 billion MPC. D) $400 billion MPC.
Answer: A Type: Analytical Page: 220

86. Refer to Figure 11.1. Assume aggregate demand is represented by AD1 and full employment is $6.0
trillion. The equilibrium level of income is:
A) $5.0 trillion. B) $5.8 trillion. C) $6.0 trillion. D) $6.2 billion.
Answer: B Type: Analytical Page: 220

87. Refer to Figure 11.1. Assume aggregate demand is initially represented by AD1 and full employment is
$6.0 trillion. If aggregate demand increases by the amount of the GDP gap, equilibrium will occur at:
A) Point b. B) Point d. C) Point e. D) Point c.
Answer: D Type: Analytical Page: 220

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88.
Refer to Figure 11.1. Assume aggregate demand is represented by AD1, full employment is $6.0
trillion, and the MPC is 0.75. The fiscal stimulus needed to reach full employment equilibrium is:
A) $1 trillion. B) $2 trillion. C) $400 billion. D) $100 billion.
Answer: D Type: Analytical Page: 220

89. Refer to Figure 11.1. Assume aggregate demand is represented by AD1 and full employment is $6.0
trillion. The aggregate demand shortfall is equal to:
A) $200 billion. B) $400 billion. C) $200 billion MPC. D) $400 billion MPC.
Answer: B Type: Analytical Page: 220

90. Refer to Figure 11.1. Assume aggregate demand is represented by AD1 and full employment is $6.0
trillion. The aggregate demand shortfall is equal to the distance between:
A) Point a and point b. B) Point b and point e. C) Point a and point e. D) Point d and point b.
Answer: C Type: Analytical Page: 220

Use the following to answer questions 91-94:


Figure 11.2

P R IC E L E V E L

A S

PE

A D 2
A D 1
Q E

Q F

R EA L G D P

91. According to Figure 11.2, a shift from AD1 to AD2 will:


A) Move equilibrium to QF.
B) Eliminate the GDP gap because of the increase in output.
C) Move equilibrium to point Y because of an increase in the price level.
D) Move the economy to point Y and then the market mechanism will move the economy to point Z.
Answer: C Type: Complex Understanding Page: 220

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92.
A shift from AD1 to AD2 in Figure 11.2 will:
A) Worsen the existing unemployment problem.
C) Cause significant inflation.
B) Reduce, but not close, the GDP gap.
D) Eliminate the GDP gap.
Answer: B Type: Analytical Page: 220

93. In Figure 11.2, if the level of spending is equal to AD1, the AD shortfall would be equal to the distance:
A) XY. B) XZ. C) YZ. D) Greater than XZ.
Answer: D Type: Analytical Page: 220

94. According to Figure 11.2, if the level of spending increased from AD1 to AD2, which of the following
statements would be correct?
A) Full employment will be reached if the price level does not change.
B) Given AS, full employment will not be reached because some of the additional spending will drive up
the price level instead of increasing output.
C) To increase AD1 to AD2 using fiscal policy, the fiscal stimulus would have to be the amount of the AD
shortfall divided by the multiplier.
D) All of the above.
Answer: D Type: Complex Understanding Page: 220

Use the following to answer questions 95-96:


Figure 11.3

P R IC E L E V E L

A S

PE

Q 1

A D 1

Q 2

Q 3

Y
A D 2

Z
A D 3

Q 4

REA L G D P

95. Using Figure 11.3, if Q3 represents full employment, then a shift from AD1 to:
A) AD2 will result in a full-employment equilibrium at point Y.
B) AD2 will close the GDP gap.
C) AD3 will take the economy past full employment to an equilibrium at point Z
D) AD3 will result in a full-employment equilibrium at point X.
Answer: D Type: Complex Understanding Page: 221

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Chapter 11: Fiscal Policy

96. Suppose Q3 represents full employment output in Figure 11.3 but equilibrium output is Q1. In order to
reach full employment output, AD must increase by the distance:
A) VY. B) VZ. C) YZ. D) VW.
Answer: B Type: Basic Understanding Page: 221

Use the following to answer question 97:


Figure 11.4

P R IC E L E V E L

P1

P2

A S

E
A D 1

A D 2

Q 3

Q 2

Q 1

R EA L G D P

97. Refer to Figure 11.4. Assume that Q2 is full employment output but the economy is in equilibrium at Q1.
Which of the following statements is correct?
A) Excess AD is a dollar amount equal to DE.
B) The GDP gap is equal to Q1 minus Q2.
C) The desired fiscal restraint is a dollar amount equal to DE divided by the multiplier.
D) All of the above.
Answer: D Type: Basic Understanding Page: 221

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Chapter 11: Fiscal Policy


Use the following to answer questions 98-99:
Figure 11.5

P R IC E L E V E L

A S

P2
P1
A D 1

Q 1

A D 2

Q 2

Q 3

R EA L G D P

98. Using Figure 11.5, which fiscal policy action would increase aggregate demand from AD1 to AD2?
A) A decrease in transfer payments.
B) A decrease in taxes.
C) A decrease in government spending.
D) A decrease in government spending matched by an equal a decrease in taxes.
Answer: B Type: Complex Understanding Page: 221

99. In Figure 11.5, assume that Q2 is full employment output and the level of aggregate spending is represented
by AD1. If AD1 increases by the dollar amount equal to Q2 minus Q1, which of the following statements is
correct?
A) Full employment will be reached.
B) Excess AD and inflation will be the result.
C) Full employment will not be reached because some of the additional spending results in higher prices
rather than higher output.
D) A lower price level will result.
Answer: C Type: Basic Understanding Page: 221

FISCAL RESTRAINT

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Chapter 11: Fiscal Policy


Use the following to answer questions 100-104:
Figure 11.6

100. Refer to Figure 11.6. Assume aggregate demand is represented by AD1 and full employment is $5.6
trillion. The economy confronts an inflationary GDP gap of:
A) $200 billion. B) $400 billion. C) $600 billion. D) $800 billion.
Answer: B Type: Analytical Page: 221

101. Refer to Figure 11.6. Assume aggregate demand is represented by AD1 and full employment is $5.6
trillion. The equilibrium level of income is:
A) $800 billion. B) $5.2 trillion. C) $5.6 trillion. D) $6.0 trillion.
Answer: D Type: Analytical Page: 221

102. Refer to Figure 11.6. Assume aggregate demand is represented by AD1 and full employment is $5.6
trillion. To restore price stability the AD curve must shift:
A) Leftward by $400 billion.
C) Leftward by $800 billion.
B) Rightward by $400 billion.
D) Rightward by $800 billion.
Answer: C Type: Analytical Page: 221

103. Refer to Figure 11.6. Assume aggregate demand is represented by AD1 and full employment is $5.6
trillion. If aggregate demand decreases by the amount of the GDP gap, equilibrium will occur at:
A) Point a. B) Point b. C) Point c. D) Point d.
Answer: C Type: Analytical Page: 221

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Chapter 11: Fiscal Policy

104. Refer to Figure 11.6. Assume aggregate demand is represented by AD1 and full employment is $5.6
trillion. The aggregate demand excess is equal to the distance between:
A) Point a and point e. B) Point a and point b. C) Point a and point d. D) Point b and point e.
Answer: A Type: Analytical Page: 221

The following multiple-choice questions require critical thinking about In the News and World View articles that
appeared in the text.
105. A World View article in the text is titled "China Races Its Spending Engines to Stave Off Effects of
Slowdown." China is attempting to stimulate its economy through:
A) Increased government spending.
C) Increased transfer payments.
B) Decreased taxes.
D) All of the above.
Answer: A Type: Basic Understanding Page: 222

106. A World View article in the text titled "China Races Its Spending Engines to Stave Off Effects of
Slowdown" discusses increased fiscal spending. The increase in spending will cause the aggregate:
A) Demand curve to shift to the left.
C) Supply curve to shift to the left.
B) Demand curve to shift to the right.
D) Supply curve to shift to the right.
Answer: B Type: Basic Understanding Page: 222

107. The In the News article titled "How the Cuts Add Up" discusses the Bush tax cuts. Tax cuts are designed to:
A) Boost consumption spending and shift aggregate demand to the left.
B) Boost consumption spending and shift aggregate demand to the right.
C) Reduce government spending.
D) Increase unemployment.
Answer: B Type: Complex Understanding Page: 224

108. An In the News article titled "How the Cuts Add Up" discusses the Bush tax cuts. Tax cuts are designed to:
A) Increase real GDP.
C) Increase consumption spending.
B) Reduce unemployment.
D) All of the above.
Answer: D Type: Complex Understanding Page: 224

109. According to one In the News article, "Economy Is Already Feeling The Impact of Federal Government's
Spending Cuts," a decrease in government spending has contributed to the sluggish economy. This would
imply that:
A) The aggregate demand curve has shifted to the right.
B) The aggregate demand curve has shifted to the left.
C) Injections into the circular flow have increased.
D) The aggregate supply curve has shifted to the right.
Answer: B Type: Complex Understanding Page: 228

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Chapter 11: Fiscal Policy

True/False Questions
TAXES AND SPENDING
T

F 110. The Sixteenth Amendment to the Constitution in 1913 made it possible for the federal government
to tax imports.
Answer: False Type: Basic Understanding Page: 218

F 111. The ranking of the size of tax revenues received by the federal government (from highest to
lowest) would be corporate taxes, income taxes, and social security payroll taxes.
Answer: False Type: Basic Understanding Page: 218

F 112. Income transfers do not involve any direct government buying, whereas government purchases are
part of aggregate demand.
Answer: True Type: Basic Understanding Page: 219

F 113. Checks for unemployment benefits sent to unemployed people are considered government
purchases.
Answer: False Type: Basic Understanding Page: 219

F 114. Defense, health, and highway spending are income transfers.


Answer: False Type: Basic Understanding Page: 219

F 115. Income transfers are payments to individuals for which no current goods or services are
exchanged.
Answer: True Type: Definition Page: 219

F 116. Government income transfers are part of aggregate demand; government purchases of goods and
services are not.
Answer: False Type: Basic Understanding Page: 219

F 117. Fiscal policy involves changes in government spending and taxes, but not regulation of prices or
production.
Answer: True Type: Basic Understanding Page: 219

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Chapter 11: Fiscal Policy

F 118. Fiscal policy changes in government spending and taxes primarily target the aggregate supply
curve.
Answer: False Type: Definition Page: 219

F 119. Fiscal policy works principally through shifts of the aggregate demand curve.
Answer: True Type: Basic Understanding Page: 219

FISCAL STIMULUS
T

F 120. From a Keynesian perspective, the way out of a recession includes an increase in government
spending, a tax cut, or an increase in transfer payments.
Answer: True Type: Basic Understanding Page: 220

F 121. Shifting the aggregate demand curve by the amount of the GDP gap will eventually achieve full
employment only if the price level remains constant.
Answer: True Type: Basic Understanding Page: 220

F 122. Increasing aggregate demand by the amount of the GDP gap will achieve full employment only if
the price level does not rise.
Answer: True Type: Basic Understanding Page: 220

F 123. A government should raise its purchases by the amount of the AD shortfall in order to reach full
employment equilibrium.
Answer: False Type: Basic Understanding Page: 221

F 124. The impact of fiscal stimulus on aggregate demand includes both the new government spending
and all subsequent increases in consumer spending triggered by the initial government outlays.
Answer: True Type: Basic Understanding Page: 221

F 125. When government spending increases, consumption also increases via the multiplier process.
Answer: True Type: Basic Understanding Page: 222

F 126. The multiplier ensures that equilibrium GDP equals full-employment GDP.
Answer: False Type: Basic Understanding Page: 222

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Chapter 11: Fiscal Policy

F 127. The desired fiscal stimulus equals the AD shortfall multiplied by the multiplier.
Answer: False Type: Basic Understanding Page: 223

F 128. A tax cut results in the same stimulus to the economy as an increase in consumption spending of
the same size.
Answer: False Type: Basic Understanding Page: 224

F 129. Tax cuts and income transfers have the same fiscal stimulus, dollar for dollar.
Answer: True Type: Basic Understanding Page: 224

F 130. Balancing new government purchases with an equivalent increase in taxes will avoid stimulus to
the economy.
Answer: False Type: Basic Understanding Page: 227

F 131. A simultaneous increase of government purchases by $50 billion and a tax hike of $50 billion
could stimulate the economy by $50 billion.
Answer: True Type: Basic Understanding Page: 227

F 132. If the federal government balanced its budget, its tax revenues would be equal to government
expenditures.
Answer: True Type: Basic Understanding Page: 227

F 133. When increases in government spending are offset by equal increases in taxes, the level of income
remains constant.
Answer: False Type: Basic Understanding Page: 227

F 134. An investment tax credit creates jobs mostly for the year in which it is granted.
Answer: False Type: Basic Understanding Page: 227

F 135. An income transfer contains less same fiscal stimulus than an increase in government spending of
the same size.
Answer: True Type: Basic Understanding Page: 227

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Chapter 11: Fiscal Policy


FISCAL RESTRAINT
T

F 136. Aggregate demand excess is the amount of additional aggregate demand needed to achieve full
employment after allowing for price-level changes.
Answer: False Type: Definition Page: 228

F 137. The desired fiscal restraint can be calculated as excess AD multiplied by the multiplier.
Answer: False Type: Basic Understanding Page: 229

F 138. If the economy has an inflationary GDP gap, one possible solution is to increase government
expenditures.
Answer: False Type: Basic Understanding Page: 229

F 139. If the economy is experiencing excess demand which is causing inflation, the inflationary
pressures can be eliminated by reducing government spending by less than the amount of excess
demand.
Answer: True Type: Basic Understanding Page: 230

F 140. If the economy has an inflationary GDP gap, one possible solution is to increase taxes.
Answer: True Type: Basic Understanding Page: 231

F 141. A decrease in transfer payments can result in a decrease in inflation.


Answer: True Type: Basic Understanding Page: 231

F 142. A decrease in transfer payments works like a tax hike because it reduces the level of disposable
income.
Answer: True Type: Basic Understanding Page: 231

FISCAL GUIDELINES
T

F 143. An increase in government expenditure can crowd out consumption and investment expenditure.
Answer: True Type: Basic Understanding Page: 232

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Chapter 11: Fiscal Policy


T
F
144.
Crowding out is the idea that an increase in government spending may cause a
reduction in private-sector spending.
Answer: True Type: Basic Understanding Page: 232

F 145. In formulating fiscal policy it is necessary to specify the amount of the desired AD shift.
Answer: True Type: Basic Understanding Page: 232

F 146. One of the limitations when using fiscal policy is that time lags exist.
Answer: True Type: Basic Understanding Page: 232

F 147. Fiscal policy formation is typically a quick process.


Answer: False Type: Basic Understanding Page: 232

F 148. Fiscal policy formation causes a delay in implementation even though a recession can usually be
recognized within a few weeks after it begins.
Answer: False Type: Basic Understanding Page: 233

Page 26