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Multiple Choice Tutorial
Chapter 7
Fiscal Policy
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1. Fiscal policy
a. uses the federal government’s power of
spending and taxation to affect
employment, price levels, and GDP
b. uses the federal government’s power over
the money supply and interest rates to
affect employment, the price level, and GDP
c. can affect employment and price, but not
the level of GDP
A. Fiscal policies are policies of the federal
government to influence demand. During
periods of inflation we would want demand to
decrease, during periods of unemployment
we would want demand to increase.
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2. At any given price level (and with other things
held constant) an increase in government
purchase or transfer payments is most likely
to decrease which of the following?
a. the amount of real GDP demanded
b. the size of the federal debt
c. the amount of unemployment
d. the supply of money
C. The purpose of an increase in government
spending when used as a fiscal policy is to put
unemployed people back to work.
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3. John M. Keynes is best known for advocating
a. a policy of annually balancing the budget.
b. deficit spending during some recessions.
c. the fixed-growth-rate monetary rule.
B. Before the Great Depression of the 1930’s
Classical economics was the accepted believe.
According the Classical thinking, the
economy was always tending toward a full
employment equilibrium, therefore there was
no need for government intervention. Keynes
believed that the economy could tend toward
a less then full employment equilibrium,
therefore, in this case, there was need for
government intervention to move the
economy to a full employment equilibrium.
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4. If government purchases of good and services
increase by $10 billion when the MPC is .8
and the MPS is therefore .2, then
a. real GDP will increase by $16 billion
b. real GDP will increase by $20 billion
c. real GDP will increase by $40 billion
d. real GDP will increase by $50 billion
D. The formula for the multiplier is 1/MPS.
Because the MPS is 2/10, which equals 1/5,
the multiplier is equal to 1 divided by 1/5 or
5. Now take the multiplier and multiply it by
the spending increase and you get 5 x $10
billion = $50 billion.
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5. When automatic stabilizers kick in to
partially counteract recessionary forces
a. aggregate demand rises above its pre-
recession level.
b. the deficit falls below its pre-recession
level.
c. the government tends to have more of a
deficit, which is intended to stimulate the
economy.
C. An example of an automatic stabilizer is
unemployment benefits. During recessions
the economy experiences insufficient
aggregate demand, the unemployment
benefits help to increase aggregate demand.
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6. The balanced budget multiplier
a. is greater than 1.
b. is less than 1.
c. is equal to 1.
d. can be more or less than 1.
C. It is equal to one because the amount of
the tax increase is the same is the extra
amount the government spends.
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7. Let’s say inflation remains stable and huge
government budget deficits drive up market
interest rates. This will cause
a. foreign investment in the U.S. to increase.
b. imports to decrease.
c. the foreign trade deficit to decrease.
d. the value of the dollar to depreciate
relative to foreign currencies.
A. As interest rates in America increase relative
to interests rates in foreign countries,
everything else remaining the same, will give
foreigners an incentive to put their money in
America to take advantage of the favorable
interest rates.
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8. Which of the following steps does not belong in
a sequence reflecting the impact on
international markets of increased borrowing?
a. the U.S. Treasury sells securities.
b. the sale of securities drives up interest rates.
c. the rising value of the dollar leads to
increased U.S. exports and reduced imports.
C. Higher interest rates in America will attract
foreign investment. But to invest in America,
foreigners need American dollars, thus the
demand for dollars increases in the world
market, increasing the dollar’s value. Foreign
products are now less expensive to Americans
and American products more expensive to
foreigners.
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9. Which of the following would neutralize and
offset the stimulating effect of deficit spending?
a. increased saving
b. increased investment spending
c. increased personal consumption
expenditures
d. a decrease in taxes
A. The more people can save, the less
dependant they will be on the government
when they retire.
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10. All of the following are variables that can be
manipulated to affect fiscal policy except
a. personal income taxes
b. government expenditures on goods and
services
c. government expenditures on
unemployment benefits
d. the rate of interest
D. A change in interest rates are influenced by
the Federal Reserve. The Fed’s ability to
increase or decrease the nation’s money
supply gives it some influence as to what
happens to interest rates.
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11. A $100 billion dollar increase in government
spending increases real GDP more than a
$100 billion reduction in net taxes because
a. some of the dollars consumers gain from
the tax reduction will be saved
b. some of the dollars consumers gain from
the tax reduction will be spent on services
c. consumers will spend some of it on foreign
goods
A. The multiple effect is greater when the
government has the $100 billion because it
will spend all of it - if citizens have the
money, they will save a portion of it -
depending on the Marginal Propensity to
Consume (MPS)
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12. When the MPC is .75, a decrease in net taxes
of $100 billion will increase the equilibrium
level of real GDP by
a. $75 billion
b. $100 billion
c. $300 billion

C. -MPC/(1-MPC) = -.75/.25 = -3; -3 x -$100
billion = $300 billion
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13. The effect of a change in net taxes on the
quantity of real GDP demanded equals the
resulting shift in the consumption function
times
a. the marginal propensity to consume
b. the marginal propensity to save
c. the autonomous net tax multiplier
C. The autonomous net tax multiplier is the
ratio of a change in equilibrium real GDP
demanded to the initial change in
autonomous net taxes that brought it about;
the numerical value of the multiplier is
-MPC/(1-MPC).
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14. When net taxes and government purchases
are reduced by the same amount
a. there will be an increase in real GDP equal
to the size of the reduction
b. there will be a decrease in real GDP equal
to the size of the reduction
c. there will be an increase in real GDP that
depends upon the size of the multiplier
d. there will be a decrease in the real GDP
depending on the size of the multiplier
D. The multiplier works in reverse. If there is a
reduction of X amount of spending, real GDP
will decrease by a multiple of that decrease.
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15. Which of the following is an example of
fiscal policy?
a. the Federal Reserve Board reduces interest
rates
b. the local school board raises teachers’
salaries
c. General Electronics Corp. borrows $100
million to build anew factory
d. the federal government reduces personal
income tax rates
D. Fiscal policies are policies of the federal
government for the purpose of increasing or
decreasing aggregate demand to fight either
unemployment or inflation.
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16. All of the following are components of the
aggregate expenditure function which may be
examples of fiscal policy except
a. government expenditure for social security
b. consumption expenditure for appliances
c. investment expenditures for capital
equipment
d. government expenditures for highway
construction
A. Government spending on Social Security is
simply a transfer payment; money is taken
from one group and given to another group.
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17. All of the following might be effective in
eliminating a contractionary gap except
a. reducing Social Security payments to
beneficiaries.
b. reducing personal income taxes.
c. increasing expenditures for the interstate
highway system.
d. increasing farm subsidies.
A. First of all, reducing Social Security
benefits would not be used as a fiscal
policy. Second, even if we did reduce the
benefits, this would depress the economy
and not stimulate it as would be needed to
correct a contractionary gap.
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18. When there is a contractionary gap, effective
fiscal policy might be to
a. reduce market prices
b. reduce interest rates
c. increase the money supply
d. increase government purchases
D. All of the above would help when we are in a
less than full employment equilibrium; but
only an increase in government purchases is a
fiscal policy, the others are monetary policies.
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19. When fiscal policy is effective in eliminating
a contractionary gap it
a. increases potential GDP
b. increases the equilibrium level of real GDP
c. increases the rate of unemployment
d. decreases the level of prices
B. Fiscal policies differ from monetary polices
in that they can shift the equilibrium. With a
Contractionary gap present the economy is
tending toward a point of less than full
employment. By shifting aggregate demand
upward, the intent is to move the equilibrium
to a full employment equilibrium.
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20. An appropriate fiscal policy to deal with an
expansionary gap is to
a. increase the rate of interest.
b. increase farm subsidy payments.
c. increase government purchases.
d. increase personal taxes.
D. An expansionary gap would exist when we
have inflation. An increase in personal taxes
would decrease taxpayers disposable income.
With the resultant decrease in demand,
prices would decline.
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21. When there is an expansionary gap, effective
fiscal policy might include all of the following
except
a. increasing personal taxes
b. increasing corporate taxes
c. increasing aggregate supply
d. decreasing government purchases
C. With an Expansionary gap the economy is
overheated. So we want to cool it down by
lowering aggregate demand. Increasing
personal taxes, increasing corporate taxes,
and decreasing government purchases lowers
aggregate demand. Increasing aggregate
supply heats the economy up.
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22. When the aggregate supply (AS) curve has a
positive slope, effective fiscal policy to correct
for an expansionary gap will
a. only reduce prices.
b. only reduce real GDP.
c. only increase prices.
d. reduce both prices and real GDP.
D. Simply draw this out on a piece of paper.
With an up-sloping curve and a down-sloping
demand curve, a shift to the left of the
demand curve will bring about a decrease in
prices (vertical axis) and an decrease in real
GDP (horizontal axis).
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23. John M. Keynes influenced the use of fiscal
policy in the U.S. by arguing effectively that
a. that balancing the national budget at all
times was sound economic policy
b. national economic forces were not
necessarily adequate to move the economy
towards its potential output level
c. the government did not need to stimulate
output in order for the economy to achieve
its potential output level
B. The biggest difference between Keynes and
the Classical economists was that Keynes
believed that the economy could tend toward
a point of less than full employment.
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24. Prior to the Great Depression of the 1930’s,
the dominant fiscal policy was
a. to lower taxes whenever unemployment
began to increase
b. to increase government purchases
whenever the nation’s output fell below its
potential output level
c. to raise taxes or reduce government
purchases whenever necessary to balance
the federal budget
C. The Classical economists did not believe in
fiscal policies to stimulate the economy during
periods of recession. However, they did believe
that it was fiscally sound for the federal
government to have a balanced budget.
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25. Which of the following is the best example of
an automatic stabilizer in fiscal policy?
a. spending more on national highways
b. paying pensions to retired military
personnel
c. paying unemployment insurance benefits
d. decreasing the supply of money
C. Automatic stabilizers go into effect during
periods of unemployment and cease when the
economy recovers. Only the payment of
unemployment benefits in the above choices
fits this description.
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26. Automatic stabilizers
a. have no effect on unemployment levels
b. have no effect on output levels
c. increase the size of the expansionary gap
d. reduce the magnitude of economic
fluctuations
D. Automatic stabilizers do not totally reverse a
decline in aggregate demand (for this to
happen the payments would have to equal all
of a person’s loss of income), but they do slow
down the downward trend.
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27. All of the following are automatic stabilizers
except
a. unemployment insurance benefits.
b. payments to welfare recipients.
c. progressive federal income taxes.
d. national defense expenditures.
D. An automatic stabilizer goes into effect
automatically when the economy takes a dive
and is taken off when the economy recovers.
Such is not the case with national defense
expenditures.
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28. Which of the following is the best example of
anti-recession discretionary fiscal policy?
a. increase in government expenditures on
public construction projects like bridges,
dams, and roads
b. a decrease in taxes on liquor and
cigarettes
c. a decrease in welfare payments
A. Discretionary fiscal policies differ from
automatic stabilizers in that they are not
automatic, but are up to the discretion of
Congress. When the government increases
spending, it is best to spend it on building our
infrastructure, like roads and bridges.
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29. The “Golden Age” of fiscal policy - that
decade in which it was most in political favor
and in which it seemed to work best - was
a. the 1930’s.
b. the 1940’s.
c. the 1950’s.
d. the 1960’s.
e. the 1970’s
D. Keynesian economics was at its peak
popularity in the 1960’s. The stagflation of
the 1970’s made us realize the limitations of
Keynesian policies.
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30. Which one of the following is not one of the
concerns most often expressed about the
effectiveness of fiscal policy?
a. the difficulty of estimating the natural rate
of unemployment.
b. the time lags involved in implementing
fiscal policy.
c. an increase in aggregate demand tends to
worsen unemployment.
C. An increase in aggregate demand will cause
an increase in employment.
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31. Stagflation is defined as the “double trouble”
of higher inflation combined with an increase
in
a. the money supply
b. unemployment
c. the price level
d. corporate profits
B. With stagflation the economy is stagnating
and inflating at the same time.
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32. The rate of unemployment that occurs when
the economy is producing its potential GDP
a. is called the natural rate of unemployment.
b. is naturally zero.
c. is thought to be approximately 10%.
d. is equal to the rate of stagflation in most
years.
A. The natural rate of unemployment equals
full employment. If, let’s say, five percent of
the labor force would be looking for work
even in the best of times, then five percent or
less of unemployment would be considered
full employment.
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33. Which of the following does not hamper the
effectiveness of discretionary fiscal policy?
a. the difficulty of estimating the natural rate
of unemployment
b. time lags involved in enacting appropriate
legislation
c. the difficulty of getting an accurate
measure of the rate of inflation
d. time lags involved in recognizing the need
for fiscal policy
C. Discretionary fiscal policies would be used
more for unemployment and not inflation.
Even if they were used for inflation, we have
no difficulty in measuring the inflation rate.
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34. People will be likely to spend a higher
percentage of any additional income when
a. they believe that the increase is permanent.
b. they believe that the increase is temporary.
c. the increase is large.
d. the increase is small.
A. One of the failings of discretionary fiscal
policies is that they can bring about changes
that consumers will view as temporary and
not permanent. It has been shown that people
will base their spending habits more on what
they consider their permanent income and
less so on their perceived temporary income.
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35. A temporary tax increase imposed in 1986
for an 18 month period failed to reduce
consumption expenditures in the U.S. by the
amount expected because
a. people viewed the tax increase as
permanent.
b. people viewed the tax increase as
temporary.
c. people chose to increase their saving.
d. consumption expenditures are unrelated to
the level of taxation.
B. This is an example of a fiscal policy that was
not effective because it was perceived as
temporary and not permanent.
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36. Changes in discretionary fiscal policy (e.g.,
taxes) and automatic stabilizers (e.g.,
unemployment insurance benefits) can have
significant unintended effects on all of the
following except
a. the incentive to work.
b. the incentive to spend.
c. the incentive to save.
d. the incentive to purchase imported goods.
D. Whether people purchase imported goods or
not has nothing to do with discretionary fiscal
policies.
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37. Raising taxes as an element of discretionary
fiscal policy is intended to reduce aggregate
demand, but it can also reduce aggregate
supply if
a. the higher taxes lead workers to seek out a
second job.
b. the higher taxes cause workers to work
less.
c. the government purchases goods with the
additional revenue.
B. With an increase in taxes tax-payers
disposable income decreases. If they use their
disposable income as a measure of if they
should work or not, workers will work less.
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38. President Reagan and the U.S. Congress
agreed on substantial changes in the federal
budget in the early 1980’s. Among these
changes was
a. a decrease in defense spending.
b. a 3% tax reduction.
c. a 13% tax reduction.
d. a 23% tax reduction.
D. We had the largest tax decrease in history
under President Reagan. The big tax
decreases in the early 1980’s contributed
greatly to the prosperity of the 1990’s.
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39. The lower tax rates enacted in the early
1980’s were intended to
a. increase the supply of labor.
b. increase the price level.
c. increase unemployment benefits.
d. reduce potential GDP.
A. This is what is called “supply side
economics.” By lowering taxes, people will
more of an incentive to work and invest.
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40. The Reagan experiment in supply-side
economics resulted in all of the following
except
a. growth in employment.
b. a period of sustained economic growth.
c. a reduction in the federal debt.
C. In the long run, a decrease in taxes will lead
to an increase in real GDP do to the increase
in economic growth. However, in the short
run, this decrease in taxes will decrease
government tax revenue and therefore add to
the national debt, assuming no decrease in
government spending. Government spending
actually increased under Reagan because of
big increases in military spending.
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41. Large federal budget deficits
a. can best be reduced by discretionary fiscal
policy.
b. make it difficult to use discretionary fiscal
policy.
c. in the mid to late 1980’s were the result of a
severe recession.
d. still constitute only about 1% of the GDP.
B. Large deficits make it difficult for
discretionary fiscal policy because the lower
taxes and/or increases in government
spending can add to the national debt.
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42. The idea that non-inflationary economic
growth can be induced by government
programs designed to increase production and
labor effort is called
a. the balanced budget multiplier.
b. the feedback effect.
c. an automatic stabilizer.
d. supply side economics.
D. Keynesian economics stresses a reliance on
the demand side of the equation. Supply side
economics dwells on the supply side of the
equation. A decrease in costs will move the
aggregate supply curve to the right, thus
prices decline and real GDP increases.
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