Practice quiz

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Chapter 11
Fiscal Policy

1. Contractionary fiscal policy is deliberate government action to influence aggregate demand and the level of real GDP through
a. expanding and contracting the money supply.
b. encouraging business to expand or contract investment.
c. regulating net exports.
d. decreasing government spendingor increasing taxes.

ANS:
d. The money supply is under control of the Federal Reserve and not Congress. Answers b and c do not involve changes in taxes or government spending.

2. The spending multiplier is defined as
a. 1 / (1 - marginal propensity to consume).
b. 1 / (marginal propensity to consume).
c. 1 / (1 - marginal propensity to save).
d. 1 / (marginal propensity to consume +marginal propensity to save).

ANS:
a. The spending multiplier is also defined as 1/MPS.

3. If the marginal propensity to consume (MPC) is 0.60, the value of the spending multiplier is
a. 0.4.
b. 0.6.
c. 1.5.
d. 2.5.

ANS:
d. Spending multiplier = 1 / (1 - MPC) = 1 / (1 - 0.60) = 1 / 40 / 100 = 5 / 2 = 2.5



4. Assume the economy is in recession and real GDP is below fullemployment. The marginal propensity to consume (MPC) is 0.80, and the government increases spending by $500 billion. As a result, aggregate demand will rise by
a. zero.
b. $2,500 billion.
c. more than $2,500 billion.
d. less than $2,500 billion.

ANS:
b. Change in aggregate demand (∆Y) = initial change in government spending (∆G) x spending multiplier.
Spending multiplier = 1 / (1 - MPC) = 1/ (1 - 0.80) = 1 / 20/100 = 5
∆Y = $500 billion x 5
∆Y = $2,500 billion

5. Mathematically, the value of the tax multiplier in terms of the marginal propensity to consume (MPC) is given by the formula
a. MPC - 1.
b. (MPC - 1) MPC.
c. 1 / MPC.
d. 1 - [1 / (1 - MPC)].

ANS:
d. The tax multiplier is also stated as tax multiplier = 1 - spending multiplier.

6. Assume the marginalpropensity to consume (MPC) is 0.75 and the government increases taxes by $250 billion. The aggregate demand curve will shift to the
a. left by $1,000 billion.
b. right by $1,000 billion.
c. left by $750 billion.
d. right by $750 billion.

ANS:
c. The tax multiplier is -3 (1 - spending multiplier) and -3 times $250 billion equals a $750 billion decrease. The movement is left because consumershave less money to spend.

7. If no fiscal policy changes are made, suppose the current aggregate demand curve will increase horizontally by $1,000 billion and cause inflation. If the marginal propensity to consume (MPC) is 0.80, federal policymakers could follow Keynesian economics and restrain inflation by decreasing
a. government spending by $200 billion.
b. taxes by $100 billion.
c.taxes by $1,000 billion.
d. government spending by $1,000 billion.

ANS:
a. Change in government spending (∆G) x spending multiplier = change in aggregate demand, rewritten:
∆G = change in aggregate demand / spending multiplier
Spending multiplier = 1 /(1-MPC) = 1/(1-0.80) = 1/ 20/100 = 5
∆G = -$1,000/5∆G = -$200 billion.

8. If no fiscal policy changes are implemented, suppose the future aggregate demand curve will exceed the current aggregate demand curve by $500 billion at any level of prices. Assuming the marginal propensity to consume (MPC) is 0.80, this increase in aggregate demand could be prevented by
a. increasing government spending by $500 billion.
b.increasing government spending by $140 billion.
c. decreasing taxes by $40 billion.
d. increasing taxes by $125 billion.

ANS:
d. Change in taxes (∆T) x tax multiplier = change in aggregate demand, rewritten:
Tax multiplier = 1 - spending multiplier
Spending multiplier = 1/(1-MPC) = 1/(1-0.80) = 1/20/100 = 5
Tax multiplier = 1 - 5 = -4, ∆T - 4 = -$500 billion
∆T = $125 billion

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