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 spending or 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 full employment. 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 marginal