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ECON102 Spring 2014 Study Guide 8 MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Figure 27- 3 1) Refer to Figure 27- 3. In the dynamic model of AD- AS in the figure above, if the economy is at point A in year 1 and is expected to go to point B in year 2, the government would most likely pursue A) expansionary fiscal policy. B) expansionary monetary policy. C) expansionary automatic stabilizers. D) contractionary monetary policy. E) contractionary fiscal policy. 2) Refer to Figure 27- 3. In the dynamic model of AD- AS in the figure above, if the economy is at point A in year 1 and is expected to go to point B in year 2, Congress and the president would most likely A) raise interest rates. B) increase the money supply and decrease the interest rate. C) increase taxes. D) increase government spending. E) increase oil prices. 3) Expansionary fiscal policy involves A) increasing taxes or decreasing government purchases. B) increasing government purchases or decreasing taxes. C) increasing the money supply and decreasing interest rates. D) decreasing the money supply and increasing interest rates. 1
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  • ECON102Spring 2014Study Guide 8

    MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

    Figure 27-3

    1)Refer to Figure 27-3. In the dynamic model of AD-AS in the figure above, if the economy is at point A inyear 1 and is expected to go to point B in year 2, the government would most likely pursueA) expansionary fiscal policy.B) expansionary monetary policy.C) expansionary automatic stabilizers.D) contractionary monetary policy.E) contractionary fiscal policy.

    2)Refer to Figure 27-3. In the dynamic model of AD-AS in the figure above, if the economy is at point A inyear 1 and is expected to go to point B in year 2, Congress and the president would most likelyA) raise interest rates.B) increase the money supply and decrease the interest rate.C) increase taxes.D) increase government spending.E) increase oil prices.

    3) Expansionary fiscal policy involvesA) increasing taxes or decreasing government purchases.B) increasing government purchases or decreasing taxes.C) increasing the money supply and decreasing interest rates.D) decreasing the money supply and increasing interest rates.

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  • 4) A recession tends to cause the budget deficit to ________ because tax revenues ________ and governmentspending on transfer payments ________.A) increase; fall; rises B) decrease; fall; risesC) increase; rise; falls D) decrease; rise; falls

    5) Expansionary fiscal policy to prevent real GDP from falling below potential real GDP would cause theinflation rate to be ________ and real GDP to be ________.A) lower; lower B) higher; lower C) higher; higher D) lower; higher

    Figure 27-1

    6)Refer to Figure 27-1. Suppose the economy is in short-run equilibrium above potential GDP and no policy ispursued. Using the static AD-AS model in the figure above, this would be depicted as a movement fromA)C to B. B)C to D. C)D to C. D) E to A. E)A to E.

    7)Refer to Figure 27-1. Suppose the economy is in short-run equilibrium below potential GDP and no fiscal ormonetary policy is pursued. Using the static AD-AS model in the figure above, this would be depicted as amovement fromA) B to A. B)A to B. C)A to E. D)C to B. E)B to C.

    8)Refer to Figure 27-1. An increase in taxes would be depicted as a movement from ________, using the staticAD-AS model in the figure above.A) B to C B)B to A C)C to D D) E to B E)A to B

    9) Suppose real GDP is $12.6 trillion and potential GDP is $12.4 trillion. To move the economy back to potentialGDP, the government shouldA) lower government purchases by an amount less than $200 billion.B) lower taxes by $200 billion.C) lower government purchases by $200 billion.D) raise taxes by an amount more than $200 billion.E) raise taxes by $200 billion.

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  • Figure 27-2

    10)Refer to Figure 27-2. In the dynamic model of AD-AS in the figure above, if the economy is at point A inyear 1 and is expected to go to point B in year 2, and no fiscal or monetary policy is pursued, then at point BA) the unemployment rate is very low.B) the economy is above full employment.C) income and profits are rising.D) firms are operating below capacity.E) there is pressure on wages and prices to rise.

    11)Refer to Figure 27-2. In the dynamic model of AD-AS in the figure above, if the economy is at point A inyear 1 and is expected to go to point B in year 2, Congress and the president would most likely pursueA) expansionary monetary policy.B) expansionary fiscal policy.C) contractionary monetary policy.D) contractionary fiscal policy.E) contractionary automatic stabilizers.

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  • Figure 27-4

    12)Refer to Figure 27-4. In the graph above, the shift from AD1 to AD2 represents the total change in aggregatedemand. If government purchases increased by $50 billion, then the distance from point A to point B________ $50 billion.A) would be less than B) may be greater than or less thanC) would be greater than D) would be equal to

    13) Suppose Congress increased spending by $100 billion and raised taxes by $100 billion to keep the budgetbalanced. What will happen to real equilibrium GDP?A) Real equilibrium GDP will rise.B) There will be no change in real equilibrium GDP.C) Real equilibrium GDP will initially rise, but then fall below its previous equilibrium value.D) Real equilibrium GDP will fall.

    14) If the tax multiplier is -1.5 and a $200 billion tax increase is implemented, what is the change in GDP,holding everything else constant? (Assume the price level stays constant.)A) a $133.33 billion decrease in GDPB) a $300 billion decrease in GDPC) a $300 billion increase in GDPD) a $133.33 billion increase in GDPE) a $30 billion increase in GDP

    15) Contractionary fiscal policy to prevent real GDP from rising above potential real GDP would cause theinflation rate to be ________ and real GDP to be ________.A) lower; lower B) higher; lower C) higher; higher D) lower; higher

    16) The increase in government spending on unemployment insurance payments to workers who lose their jobsduring a recession and the decrease in government spending on unemployment insurance payments toworkers during an expansion is an example ofA) automatic monetary policy. B) discretionary monetary policy.C) automatic stabilizers. D) discretionary fiscal policy.

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  • 17) Assume a closed economy with fixed taxes and the marginal propensity to consume is equal to 0.9. What isthe government spending multiplier?A) 10 B) 9 C) 5 D) 1

    18) If the economy is falling below potential real GDP, which of the following would be an appropriate fiscalpolicy to bring the economy back to long-run aggregate supply? An increase inA) government purchases.B) taxes.C) oil prices.D) the money supply and a decrease in interest rates.

    19) Crowding out refers to a decline in ________ as a result of an increase in ________.A) government purchases; private expenditures B) tax revenues; unemploymentC) private expenditures; government purchases D) government purchases; tax rates

    20) The government purchases multiplier equals the change in ________ divided by the change in ________.A) consumption spending; government purchasesB) equilibrium real GDP; government purchasesC) government purchases; equilibrium real GDPD) government purchases; consumption spending

    SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.

    21) What is expansionary fiscal policy? What is contractionary fiscal policy?

    22) Calculate the value of the government purchases multiplier if the marginal propensity to consume equals0.9, the tax rate equals 0.25, and the marginal propensity to import equals 0.15.

    23) What are the key differences between how we illustrate an expansionary fiscal policy in the basic aggregatedemand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

    24) If real GDP is $300 billion below potential GDP and the tax multiplier equals -1.5, then how much would thegovernment need to change taxes to bring the economy to equilibrium at potential?

    25) The problem typically during a recession is not that there is too little money, but too little spending. If theproblem was too little money, what would be its cause? If the problem was too little spending, what couldbe its cause?

    26) How can tax simplification be beneficial to the economy?

    27) What is the difference between fiscal policy and monetary policy?

    28) If the federal budget goes from a budget deficit in Year 1 to a budget surplus in Year 2, does it follow that thefederal government acted to raise taxes or cut government spending in Year 2?

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  • Table 27-1

    Year Potential Real GDP Real GDP Price Level1 $11.0 trillion $11.0 trillion 1002 11.5 trillion 11.7 trillion 109

    29)Refer to Table 27-1. Suppose the economy is in the state described by the table above. What problem willoccur in the economy if no policy is pursued? What fiscal policy tools could be used to combat the problem?Draw a dynamic aggregate demand and aggregate supply diagram to illustrate the appropriate fiscal policyto use in this situation.

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  • Answer KeyTestname: STUDY GUIDE 8 S2014

    1) E2) C3) B4) A5) C6) B7) C8) B9) A10) D11) B12) C13) A14) B15) A16) C17) A18) A19) C20) B21) An expansionary fiscal policy is a decrease in taxes or an increase in government purchases intended to increase

    aggregate demand. A contractionary fiscal policy is an increase in taxes or a decrease in government purchasesintended to decrease aggregate demand.

    22) Government purchases multiplier = 1 / 1 - (0.9(1 - 0.25) - 0.15) = 2.1123) In the basic aggregate demand and aggregate supply model, expansionary fiscal policy is illustrated by a rightward

    shift of the aggregate demand curve, with the short-run aggregate supply curve and long-run aggregate supplycurve remaining stationary. The dynamic aggregate demand and aggregate supply model takes into account theeconomy experiencing continuing inflation from year to year and the economy experiencing long-run growth. Inthe dynamic model, expansionary fiscal policy is illustrated by a rightward shift of the aggregate demand curve, arightward shift of the short run aggregate supply curve, and a rightward shift of the long run aggregate supplycurve.

    24) The government would need to cut taxes by $200 billion. Plugging the values into the tax multiplier equationyields: -1.5 = $300 billionChange in taxes . The change in taxes equals

    $300 billion-1.5 , or -$200 billion.

    25) Too little money would be caused by too small of a money supply by the Federal Reserve. Too little spending couldbe caused by a variety of reasons such as a decrease in consumption spending by households because they becomepessimistic about the future, a decrease in investment spending by firms because they lower their estimates of thefuture profitability of new factories and machinery, or a decrease in U.S. exports because a major trading partner isin a recession.

    26) Tax simplification would free up resources in the economy. The complexity of the tax code has created an entireindustry to assist taxpayers in preparing their tax forms. If tax simplification reduces the need for tax preparationassistance, the resources used in this industry could be allocated to some other productive endeavor. This isbeneficial, as it would reduce wasted resources.

    Simplifying the tax code would increase economic efficiency by reducing the time and trouble firms and householdsspend solely to reduce their tax payments.

    27) Fiscal policy involves changes in federal taxes and purchases and is implemented by Congress and the President.Monetary policy involves changes in the money supply and interest rates and is implemented by the FederalReserve. Both are intended to achieve macroeconomic objectives.

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  • Answer KeyTestname: STUDY GUIDE 8 S2014

    28) No, the economy could have been in an expansion in Year 2 with GDP growing faster than anticipated. The fastergrowth in GDP would raise tax revenues and decrease government spending on transfer payments, decreasing thebudget deficit (in this case, moving it to a budget surplus).

    29)

    The economy begins in equilibrium at point A, at potential real GDP of $11 trillion and a price level of 100. Withoutgovernment policy, aggregate demand will shift from AD1 to AD2 (without policy). Because long-run aggregatesupply shifted from LRAS1 to LRAS2, the economy is pushed above potential real GDP. The economy will be at ashort-run equilibrium at point B, with real GDP of $11.7 trillion and a price level of 109.

    The government should pursue contractionary fiscal policy by decreasing government purchases or raising taxes toshift aggregate demand to AD2 (without policy). The economy will be in equilibrium at point C with real GDP of$11.5 trillion and a price level of 105. The price level is lower than it would have been if expansionary fiscal policyhad not been used.

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