ECON 0110 Lecture Notes - Lecture 17: Bachelor Of Business Administration, Allegheny River, Balanced Budget Amendment
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According to the Ricardian equivalence theorem, what is the effect of each of the following on output in the economy? Explain your answers.
a. Government pays for an increase in spending by raising taxes.
| Output increases because people will decrease their consumption by the same amount that spending increases. | |
| Output is not affected because people will increase their consumption by the same amount that spending increases. | |
| Output is not affected because people will decrease their consumption by the same amount that spending increases. | |
| Output decreases because people will decrease their consumption by the same amount that spending increases. | |
| Output increases because people will increase their consumption by the same amount that spending increases. |
b. Government pays for an increase in spending by issuing bonds.
| Output is not affected because people will decrease their savings, offsetting the increase in the deficit. | |
| Output is not affected because people will increase their savings, offsetting the increase in the deficit. | |
| Output decreases because people will decrease their savings, offsetting the increase in the deficit. | |
| Output increases because people will increase their savings, offsetting the increase in the deficit. | |
| Output decreases because people will increase their savings, offsetting the increase in the deficit. | |
| Output increases because people will decrease their savings, offsetting the increase in the deficit. |
c. The implication of your answers to a and b is that government should:
| always balance the budget regardless of the state of the economy. | |
| balance the budget only if the economy is in recession. | |
| balance the budget only if the economy is at full employment. | |
| balance the budget only if the economy is expanding. |
Assume that the equations below describe the expenditures within a particular macroeconomy and that these equations conform to the assumptions we've made in the lecture regarding the fixed price level Aggregate Expenditure model. All values for expenditure and income are dollar amounts, but for simplicity, we've dropped the $ below.
| C = 0.8(DI) + 1000 | C = Consumption expenditure, DI = Disposable Income |
| I = 2000 | I = Investment expenditure |
| G = 1000 | G = government expenditure |
| X = 1600 | X = spending on exports |
| M = 1800 | M = spending on imports |
| DI = Y - T | Y = real GDP, T = tax revenues/> |
| T = 1000 | |
| Yp = 12000 | Yp = Potential GDP |
Given the equations above, we can describe the GDP, government budget, and net exports in this economy. Select three characteristics from the list below which accurately describe this economy. Note that there is no partial credit on this question. I.e., your answer will either be all correct, or all wrong.
| a. |
inflationary gap |
|
| b. |
recessionary gap |
|
| c. |
no output gap |
|
| d. |
government budget surplus |
|
| e. |
government budget deficit |
|
| f. |
balanced government budget |
|
| g. |
trade deficit |
|
| h. |
trade surplus |
|
| i. |
net exports of zero |
1.Ceteris paribus, if the U.S. federal government reduces its budget deficit which of the following will be observed?
Answer
| a. | The aggregate demand curve will shift to the right. | |
| b. | The economy will always approach potential GDP. | |
| c. | The marginal propensity to consume will increase. | |
| d. | The average price level will increase. | |
| e. | The aggregate demand curve will shift to the left. |
2. If the government wants to close a GDP gap, it can:
Answer
| a. | lower government spending on social security. | |
| b. | adopt contractionary fiscal policies to control inflation. | |
| c. | increase its budget deficit. | |
| d. | repay its borrowings. | |
| e. | raise both direct and indirect tax rates. |
3. Suppose the short-run equilibrium level of income exceeds the full employment level of income and there is high inflation. Hence, the government decides to implement a fiscal policy that will act to reduce national output and price level. This can be accomplished by:
Answer
| a. | lowering average tax rates such that aggregate supply is increased. | |
| b. | increasing government spending such that aggregate expenditures are increased. | |
| c. | increasing transfer payments such that aggregate expenditures decline. | |
| d. | raising taxes and government spending by the same amount such that aggregate supply is decreased and aggregate demand is increased. | |
| e. | decreasing government spending such that aggregate demand is reduced. |
4. A drop in investment spending caused by increased government budget deficits is referred to as:
Answer
| a. | the multiplier effect. | |
| b. | crowding out. | |
| c. | an expansionary gap. | |
| d. | the paradox of thrift. | |
| e. | the Ricardian equivalence. |
5. Discretionary fiscal policy is best defined as:
Answer
| a. | the deliberate manipulation of the money supply to expand the economy. | |
| b. | the deliberate change in tax laws and government spending to change equilibrium income. | |
| c. | the policy action taken by the Congress to reduce the federal budget deficit. | |
| d. | the arbitrary fluctuation in tax laws and budget requirements. | |
| e. | the automatic change in certain fiscal instruments when real GDP changes. |
6. Which of the following can be considered as an automatic stabilizer in the economy?
Answer
| a. | Money supply | |
| b. | Disposable income | |
| c. | Real exchange rate | |
| d. | Real interest rate | |
| e. | Unemployment insurance |
7. Which of the following is true about automatic stabilizers?
Answer
| a. | When income rises, automatic stabilizers increase/boost spending. | |
| b. | Automatic stabilizers are a part of discretionary fiscal policy. | |
| c. | An automatic stabilizer is any program that responds to fluctuations in the business cycle in a way that moderates the effects of those fluctuations. | |
| d. | Any kind of trade policy adopted by the government will be considered as an automatic stabilizer. | |
| e. | The interest rate is an example of an automatic stabilizer. |
8. Increased budget deficits
Answer
| a. | can cause interest rates to increase and hence decrease net exports | |
| b. | have no effect on net exports | |
| c. | can cause interest rates to decrease and hence increase net exports | |
| d. | never impose additional interest costs on the government |
9. The Ricadian Equivalence implies that when financing additional government expenditures
Answer
| a. | there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will decrease either way. | |
| b. | there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will increase either way. | |
| c. | increasing borrowing is the best option | |
| d. | increasing current taxes is the best option |
10. Assuming no effects on aggregate supply, if the government increases government spending and decreases taxes in an attempt to prevent a possible recession, aggregate demand will shift to the ____, the price level will either remain constant or ____, and the level of real GDP will ____.
Answer
| a. | right; decrease; increase | |
| b. | right; decrease; decrease | |
| c. | left; decrease; decrease | |
| d. | left; increase; increase | |
| e. | right; increase; increase |
11. For a hypothetical economy, the MPS is 0.08 and the MPI is 0.17. If government spending increases by $35 and taxes increase by $35, what will be the net effect on equilibrium income?
Answer
| a. | A decrease of $35 | |
| b. | An increase of $105 | |
| c. | An increase of $35 | |
| d. | A decrease of $105 | |
| e. | A decrease of $15 |
1.
12.12. The term fiscal policy refers to
Answer
| a. | the adjustment of the GDP for inflation. | |
| b. | the purchase and sale of U.S. government securities to regulate the money supply. | |
| c. | the use of government spending and taxation to influence the level of economic growth and inflation. | |
| d. | the use of fines to penalize unfair business practices. | |
| e. | a policy action by Congress to overrule unpopular budget cuts by the president. |
13. If aggregate demand intersects aggregate supply in the vertical range of the aggregate supply curve, then, other things equal, an increase in government spending will
Answer
| a. | raise the price level and leave real GDP unchanged. | |
| b. | raise real GDP by the amount indicated by the government spending multiplier and leave the price level unchanged. | |
| c. | raise both real GDP and the price level by a multiple of the initial spending increase. | |
| d. | have no effect on real GDP or on the price level, because all private investment will be crowded out. | |
| e. | lower real GDP by an amount equal to the spending increase and reduce inflation. |
14. Which of the following is not a means to finance government spending?
Answer
| a. | Government subsidies | |
| b. | Government debt | |
| c. | Capital gains taxes | |
| d. | Personal income taxes | |
| e. | Money creation |
15. An automatic stabilizer is
Answer
| a. | a change in government spending aimed at achieving a policy goal. | |
| b. | an element of fiscal policy that automatically changes in value as real GDP changes. | |
| c. | an element of monetary policy that automatically changes in value as real GDP changes. | |
| d. | a decrease in tax rates as the economy moves into a recession. | |
| e. | a deliberate change in taxation aimed at increasing real GDP. |
16. Budget deficits tend to grow during recessions because
Answer
| a. | real GDP growth is zero, which causes neither tax receipts nor government expenditures to grow. | |
| b. | real GDP growth is positive, which reduces both tax receipts and transfer payments. | |
| c. | real GDP growth is negative, which reduces transfer payments in relation to tax receipts. | |
| d. | real GDP growth is negative, which reduces tax receipts in relation to government expenditures. | |
| e. | real GDP growth is positive, which increases tax receipts in relation to government expenditures. |