Economics (McConnell), AP Edition, 20th Edition Chapter (22)

Chapter 31: Fiscal Policy, Deficits, and Debt Multiple-Choice Questions 1. An increase in government spending increases the real GDP by more than the amount of the initial spending because of the (A) automatic stabilizers (B) spending multiplier (C) trade deficit (D) aggregate supply (E) national debt (B) The multiplier increases the value of the initial spending as the income is spent and re-spent throughout the circular flow. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Multiplier and Crowding-Out Effects Book Section: Expansionary Fiscal Policy 2. A reduction in personal taxes will cause (A) unemployment to increase (B) the price level to decrease (C) aggregate demand to decrease (D) real GDP to increase (E) the budget deficit to decrease (D) A reduction in taxes leads to an increase in disposable income, which will increase household consumption and saving. An increase household consumption will increase aggregate demand, real GDP, and the price level. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Demand-Side Effects Book Section: Expansionary Fiscal Policy 3. If a country is experiencing significant cyclical unemployment, how would an increase in government spending affect real output, the price level, and unemployment? Real Output Price Level Unemployment (A) Increase Increase Increase (B) Decrease Decrease Increase (C) Increase Increase Decrease (D) Decrease Decrease Decrease (E) Increase Decrease Decrease (C) An increase in government spending increases aggregate demand, raising real GDP and the price level while reducing unemployment. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Expansionary Fiscal Policy 4. If the government decides to use contractionary fiscal policy while having to increase government spending, it must increase taxes by (A) the same amount that it raises spending (B) the full amount of the inflationary GDP gap (C) more than it raises spending (D) less than it raises spending (E) the percentage increase in the inflation rate (C) Taxes are less effective than spending because consumers will pay part of the tax increase with savings, so consumption will not fall as far as it would if the government decreased spending by the same amount. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Contractionary Fiscal Policy 5. When the government implements an expansionary fiscal policy to resolve a recessionary gap, it results in a (A) budget deficit (B) reduction in interest rates (C) reduction in the national debt (D) budget surplus (E) reduction in real GDP (A) An expansionary fiscal policy creates a budget deficit, as taxes are reduced and government spending increases. The additional government borrowing increases real interest rates in the loanable funds market and increases the national debt. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Expansionary Fiscal Policy 6. A situation in which the federal government's expenditures are greater than its revenues in one year is (A) a budget deficit (B) a budget surplus (C) the national debt (D) a trade deficit (E) a trade surplus (A) A budget deficit counts overspending in one year; the national debt is the total amount of money the government owes. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Government Deficits and Debt Book Section: Expansionary Fiscal Policy 7. The federal government finances deficits by (A) raising taxes (B) selling exports (C) lowering spending (D) selling bonds (E) selling stock (D) Government sells Treasury bonds on the open market to borrow money to fund deficit spending. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Government Deficits and Debt Book Section: Ownership 8. When aggregate demand decreases, price levels may not adjust easily downward to the new full-employment equilibrium because (A) price levels are most effectively reduced by changing taxes (B) aggregate supply must be decreased to reduce the price level (C) price levels are most effectively reduced by changing spending (D) wages tend to be inflexible (E) a decrease in aggregate demand will reduce prices to their original levels (D) Because workers tend to be hired on contract, firms cannot quickly reduce wages in the short run. Therefore, wages tend to be inflexible (sticky). Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Sticky versus Flexible Wages and Prices Book Section: Expansionary Fiscal Policy 9. Automatic stabilizers have an advantage over discretionary fiscal policy because automatic stabilizers (A) are directed by the president, while fiscal policy is set by Congress (B) are stronger than fiscal policy tools (C) do not add to the national debt (D) affect the money supply more than they affect discretionary fiscal policy (E) take effect without requiring action by policymakers (E) Automatic stabilization programs, such as unemployment benefits or food stamps, go into effect quickly as households become eligible for the programs, avoiding the lag time involved with discretionary fiscal policy. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Stabilization Policies Book Section: Automatic or Built-In Stabilizers 10. Crowding-out occurs when (A) a product price is set too low, creating a shortage (B) too many producers are in a market, forcing some firms out of an industry (C) too many firms request government subsidies in the same budget cycle (D) government spending is reduced, so programs are eliminated (E) government borrowing increases interest rates, so firms reduce investment (E) Government's increased demand for funds in the loanable funds market raises interest rates, so firms reduce their borrowing, lowering their investment in capital goods. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Multiplier and Crowding-Out Effects Book Section: Crowding-Out Effect 11. Concerns about the size of the national debt include all of the following EXCEPT (A) interest on the debt consuming a larger portion of the national budget (B) the redistribution of income from those with lower incomes to those with higher incomes (C) lower interest rates as a result of increased government borrowing (D) the increase in the level of foreign-owned debt (E) the impact of crowding-out on future economic growth (C) Increased government borrowing raises interest rates. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Government Deficits and Debt Book Section: The U.S. Public Debt 12. All the following are fiscal policy actions that will reduce inflationary pressure on the economy EXCEPT (A) a reduction in government spending (B) an increase in the personal tax rate (C) a decrease in the amount of money in circulation (D) a decrease in transfer payments (E) an increase in the corporate tax rate (C) A decrease in the amount of money in circulation is not a fiscal policy action; it is a monetary policy action that would reduce the inflationary pressure on the economy. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Contractionary Fiscal Policy 13. Which of the following are expansionary fiscal policy actions? I. Reduction in Social Security withholding taxes II. Purchase of government bonds in the open market III. Increase in the corporate tax rate IV. Decrease in the personal tax rate (A) I only (B) II and III only (C) I and IV only (D) II, III, and IV only (E) I, II, III, and IV (C) Though it would be expansionary, the purchase of government bonds in the open market is a monetary policy action, not a fiscal policy action. While an increase in the corporate tax rate is a fiscal policy action, it is contractionary. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Expansionary Fiscal Policy 14. An expansionary fiscal policy decision requires that the government borrow in order to cover budget deficits. This borrowing will most likely impact the demand for money, interest rate, business investment demand for physical capital, and the ultimate fiscal policy expansion as follows Business Fiscal Policy Money Demand Interest Rate Investment Expansion (A) Increases Increases Increases Decreased (B) Increases Increases Increases Increased (C) Increases Increases Decreases Decreased (D) Decreases Increases Decreases Decreased (E) Decreases Decreases Increases Increased (C) The potential risk of expansionary fiscal policy is that the government will run a budget deficit and have to borrow. In doing so, the government will increase the demand for loanable funds in the loanable funds market, causing the interest rate to increase. The higher interest reduces business investment. The potential consequence is that the expansionary fiscal policy could be neutralized by the decrease in private investment spending, known as the crowding-out effect. Difficulty: Hard Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Crowding-Out Effect 15. If the economy is facing a recession, an appropriate fiscal policy action would be to I. increase the money supply II. increase government spending III. reduce taxes (A) I only (B) II only (C) I and III only (D) II and III only (E) I, II, and III (D) Increasing the money supply, while expansionary, is a monetary policy, not a fiscal policy Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policy Book Section: Expansionary Fiscal Policy 16. In order to increase initial consumption by a specific amount (A) the smaller the MPC, the smaller a tax cut will be needed (B) the smaller the MPC, the larger a tax cut will be needed (C) the larger the MPS, the smaller a tax cut will be needed (D) the smaller the MPS, the larger a tax cut will be needed (E) the larger the MPC, the larger a tax cut will be needed (B) If the marginal propensity to consume is small, government will have to cut taxes by a larger amount to put the needed spending into the economy. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policy Book Section: Expansionary Fiscal Policy 17. As shown in the graph above, investment demand is $25 billion at an interest rate of 6%. The government decides to increase borrowing to refinance existing public debt. The additional government borrowing increases the real interest rate from 6% to 10%. The most likely consequence will be that domestic investment demand (ID1) will (A) increase from ID1 to ID2 but the quantity of investment demand will remain constant at $25 billion (B) increase to $35 billion (C) remain constant but the quantity of investment demand will decrease from $25 billion to $15 billion (D) increase from ID1 to ID2 but the quantity of investment demand will fall from $25 billion to $10 billion (E) increase from ID1 to ID2 but the quantity of investment demand will fall from a potential of $35 billion to $25 billion (C) The government’s decision to increase borrowing to refinance existing public debt will not change or improve businesses’ investment prospects (expectations). Therefore, an increase in government borrowing to refinance old debt will increase the real interest rate to 10% and reduce the quantity of business investment demand from $25 billion to $15 billion. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Multiplier and Crowding-Out Effects Book Section: Crowding-Out Effect Revisited 18. In terms of expansionary fiscal policy, tax cuts are less effective than government spending increases because (A) tax cuts reduce aggregate demand (B) increases in government spending reduce the national debt (C) taxpayers prefer to have more government programs and fewer tax cuts (D) firms invest more than the amount of the tax cut (E) households save part of a tax cut (E) All of an increase in government spending goes directly into the economy to increase aggregate demand. If households save part of a tax cut, that money will not directly increase aggregate demand, reducing the effectiveness of the fiscal policy. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policy Book Section: Expansionary Fiscal Policy 19. Economists who believe a country faces many unmet social and infrastructure needs would recommend that government officials (A) increase taxes during a recession (B) increase government spending during a recession (C) reduce government spending during a recession (D) reduce taxes during a recession (E) increase government spending during a period of inflation (B) The increase in government spending would not only increase aggregate demand to reduce the effects of the recession, but it would also help to achieve the policy goals of improved infrastructure and social systems. Difficulty: Medium Style: Application AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Policy Options: G or T? 20. Each of the following policies serves as an automatic stabilizer in the U.S economy EXCEPT: (A) Social Security benefits (B) progressive income taxes (C) unemployment compensation (D) welfare payments (E) food stamps (A) Social Security benefits do not automatically increase during recessions or fall during periods of inflation, so they have no counter-cyclical effect. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Stabilization Policies Book Section: Automatic or Built-In Stabilizers 21. As Country G slides into recession, policymakers are concerned about the increasing national debt. To curb the debt, lawmakers raise taxes and significantly cut government spending. As a result of these debt reduction policies (A) short-run aggregate supply will increase (B) short-run aggregate supply will decrease (C) aggregate demand will increase (D) aggregate demand will decrease (E) aggregate demand and short-run aggregate supply will increase (D) An increase in taxes and a reduction in government spending (austerity measures) may be intended to reduce the debt, but will push the economy into an even more severe recession. Difficulty: Easy Style: Application AP Economics Curricular Requirement Macroeconomics: Stabilization Policies Book Section: Contractionary Fiscal Policy 22. Fiscal policy can be difficult to implement for all of the following reasons EXCEPT (A) It takes time for policymakers to recognize a recession is occurring. (B) It takes time for Congress to pass and implement fiscal policy. (C) It takes time for fiscal policy to affect output, employment, or the price level. (D) Fiscal policy decisions can be made (or rejected) for political reasons. (E) Congress prefers to leave fiscal policy decisions to the Federal Reserve. (E) Fiscal policy is made by Congress and the President; monetary policy is made by the Federal Reserve. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Problems, Criticisms, and Complications of Implementing Fiscal Policy 23. During recessions, federal government officials find their expansionary fiscal policy actions thwarted by the actions of state and local government officials, who are raising taxes and lowering spending because most state and local governments (A) are required to balance their budgets annually (B) philosophically oppose the use of fiscal policy (C) are more concerned about crowding out (D) are such a small part of the national economy that their policy actions will be ineffective (E) are more concerned about policy impacts on businesses than on consumers (A) Balanced budget amendments and legislation force state and local lawmakers to raise taxes and lower spending during recessions in order to balance the budget. Those actions, however, intensify the recession and counteract the efforts of federal policymakers, who are taking the opposite actions. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Offsetting State and Local Finance 24. The crowding-out effect tends to be weak during recessions because (A) government is less likely to experience a deficit during a recession (B) fiscal policy calls for a reduction in government spending during a recession (C) the higher interest rates earned by lenders stimulate the economy (D) private investment declines during a recession (E) consumer spending declines during a recession (D) Although increased government borrowing increases demand in the loanable funds market, the decrease in demand for loanable funds by the investment sector mitigates the increase in interest rates. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Multiplier and Crowding-Out Effects Book Section: Crowding-Out Effect Revisited 25. Two-thirds of the U.S. public debt is held by (A) foreign bondholders (B) American bondholders (C) foreign stockholders (D) American stockholders (E) state and local governments (B) Americans hold 67% of the U.S. public debt in Treasury bills, Treasury notes, Treasury bonds, and U.S. savings bonds. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Government Deficits and Debt Book Section: Ownership Free-Response Question Assume the economy is operating at less than full-employment output and the federal budget is balanced. (a) Using a correctly labeled aggregate supply and aggregate demand graph, show the following. (i) Real output (ii) Price level (b) Identify one fiscal policy the government could use to return the economy to full-employment output. (i) Explain how that policy works to achieve full-employment output. (ii) Identify the effect of the policy on the federal budget. (iii) Identify the effect of the policy on the national debt. (c) On the graph you drew for part (a), show the effect of the fiscal policy you identified in part (b). Identify the effects of the fiscal policy on each of the following. (i) Real output (ii) Price level (iii) Employment (d) Using a correctly labeled loanable funds market graph, show the effect of the policy you identified in part (b) on the loanable funds market. Explain the effect on each of the following. (i) The interest rate (ii) Investment Free-Response Explanation 15 points (3 + 4 + 4 + 4) (a) 3 points: 1 point is earned for a correctly labeled aggregate supply and aggregate demand graph. 1 point is earned for identifying real output (GDP). 1 point is earned for identifying the price level. (b) 4 points: 1 point is earned for identifying either an increase in government spending or a decrease in taxes. 1 point is earned for explaining that lower taxes allow consumers and firms more disposable income to increase aggregate demand or that higher government spending directly increases aggregate demand, raising incomes. 1 point is earned for stating that the policy would cause a budget deficit. 1 point is earned for stating that the deficit would increase the national debt. (c) 4 points: 1 point is earned for showing an increase in aggregate demand. 1 point is earned for stating that real output will increase. 1 point is earned for stating that the price level will increase. 1 point is earned for stating that employment will increase in order to make the additional output. (d) 4 points: 1 point is earned for a correctly labeled loanable funds market graph. 1 point is earned for showing an increase in demand for loanable funds. 1 point is earned for explaining that the interest rate increases due to increased demand. 1 point is earned for explaining that investment falls because of the higher interest rate firms must pay to borrow. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policies Book Section: Fiscal Policy, Deficits, and Debt