Short-answer Problems

1. Give a brief definition of fiscal policy? What are its economic goals?

2. Explain the aspects of expansionary and contractionary fiscal policy. During which phases of the business cycle would each be appropriate?

3. Differentiate between discretionary fiscal policy and nondiscretionary or built-in stabilization policy.

4. Explain the effect of a discretionary cut in taxes of $40 billion on the economy when the economy's marginal propensity to consume is 0.75. How does this discretionary fiscal policy differ from a discretionary increase in government spending of $40 billion?

5. Explain the five problems, criticisms, or complications that arise in the implementation of fiscal policy.

6. Can the large public debt cause the nation to go bankrupt? Explain.

7. Is the public debt a burden on future generations? Explain.

Multi-Choice Questions

1. Countercyclical discretionary fiscal policy calls for:

A. surpluses during recessions and deficits during periods of demand-pull inflation.

B. deficits during recessions and surpluses during periods of demand-pull inflation.

C. surpluses during both recessions and periods of demand-pull inflation.

D. deficits during both recessions and periods of demand-pull inflation.

2. Fiscal policy refers to the:

A. manipulation of government spending and taxes to stabilize domestic output, employment, and the price level.

B. manipulation of government spending and taxes to achieve greater equality in the distribution of income.

C. altering of the interest rate to change aggregate demand.

D. fact that equal increases in government spending and taxation will be contractionary.

3. Expansionary fiscal policy is so named because it:

A. involves an expansion of the nation's money supply.

B. necessarily expands the size of government.

C. is aimed at achieving greater price stability.

D. is designed to expand real GDP.

4. An economist who favors smaller government would recommend:

A. tax cuts during recession and reductions in government spending during inflation.

B. tax increases during recession and tax cuts during inflation.

C. tax cuts during recession and tax increases during inflation.

D. increases in government spending during recession and tax increases during inflation.

5. An economist who favored expanded government would recommend:

A. tax cuts during recession and reductions in government spending during inflation.

B. tax increases during recession and tax cuts during inflation.

C. tax cuts during recession and tax increases during inflation.

D. increases in government spending during recession and tax increases during inflation.

6. If the MPS in an economy is 0.1, government could shift the aggregate demand curve rightward by $40 billion by:

A. increasing government spending by $4 billion.

B. increasing government spending by $40 billion.

C. decreasing taxes by $4 billion.

D. increasing taxes by $4 billion.

7. If the MPC in an economy is 0.8, government could shift the aggregate demand curve rightward by $100 billion by:

A. increasing government spending by $25 billion.

B. increasing government spending by $80 billion.

C. decreasing taxes by $25 billion.

D. decreasing taxes by $100 billion.

8. Which of the following represents the most expansionary fiscal policy?

A. a $10 billion tax cut

B. a $10 billion increase in government spending

C. a $10 billion tax increase

D. a $10 billion decrease in government spending

9. One timing problem with fiscal policy to counter a recession is a "recognition lag" that occurs between the:

A. Start of the recession and the time it takes to recognize that the recession has started

B. End of the recession and the time it takes to recognize that the recession has ended

C. Time fiscal action is taken and the time that the action has its effect on the economy

D. Time the need for the fiscal action is recognized and the time that the action is taken

10. The crowding-out effect suggests that:

A. tax increases are paid primarily out of saving and therefore are not an effective fiscal device.

B. government borrowing to finance the public debt increases the real interest rate and reduces private investment.

C. it is very difficult to have excessive aggregate spending in a capitalist economy.

D. consumer and investment spending always vary inversely.

11. Which of the following best describes the idea of a political business cycle?

A. Politicians are more willing to cut taxes and increase government spending than they are to do the reverse.

B. Fiscal policy will result in alternating budget deficits and surpluses.

C. Politicians will use fiscal policy to cause output, real incomes, and employment to be rising prior to elections.

D. Despite good intentions, various timing lags will cause fiscal policy to reinforce the business cycle.

12. Which of the following is not considered a legitimate concern of a large public debt?

A. Bankruptcy of the Federal government

B. Disincentives created by higher taxes

C. Crowding-out of private investment

D. Increased income inequality

13. The real burden of an increase in the public debt:

A. may be very small or conceivably zero when the economy is in a severe depression.

B. will be smaller when full employment exists than when the economy has large quantities of idle resources.

C. can be shifted to future generations if the debt is internally financed.

D. can best be measured by the dollar increase in the size of the debt.

14. A major advantage of the built-in or automatic stabilizers is that they:

A. simultaneously stabilize the economy and reduce the absolute size of the public debt.

B. automatically produce surpluses during recessions and deficits during inflations.

C. require no legislative action by Congress to be made effective.

D. guarantee that the Federal budget will be balanced over the course of the business cycle.

15. One advantage of automatic fiscal policy over discretionary fiscal policy is that automatic fiscal policy:

A. Makes the actual budget a better reflection of the condition of the economy than the Standardized budget

B. Does not produce a cyclical deficit as discretionary policy does

C. Is not subject to the timing problems of discretionary policy

D. Has a greater multiplier effect than discretionary policy