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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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