ECO 203
PROBLEM SET 6

1. Which of the following best illustrates the use of discretionary fiscal policy?

a. Congress provides $1 billion in relief aid for hurricane victims.

b. Congress appropriates $500 million to help the needy, and the appropriation is financed by a tax on wealth.

c. Income tax receipts are smaller because of a decline in real GDP during a recession.

d. The Federal Reserve tightens credit when it receives news of accelerating inflation.

e. Congress passes a bill authorizing $2 billion in additional spending when it receives news of a deepening recession.

2. Fiscal policy focuses on manipulating

a. aggregate demand to smooth out business fluctuations

b. aggregate supply to smooth out business fluctuations

c. both aggregate supply and aggregate demand to smooth out business fluctuations

d. aggregate demand to stimulate the economy and aggregate supply to contract it

e. short-run aggregate supply to stimulate the economy and aggregate demand to contract it

3. If the MPC equals 0.75 and G increases by $100, real GDP demanded will increase by

a. 75 percent

b. 25 percent

c. $50

d. $200

e. $400

4. If equilibrium real GDP demanded rises from $4 trillion to $6 trillion when government purchases increase by $1 trillion, how large is the marginal propensity to consume?

a. 0.8

b. 0.4

c. 0.5

d. 0.2

e. 2

5. The effect of a change in net taxes on the quantity of real GDP demanded equals the resulting shift in the consumption function times

a. the marginal propensity to consume

b. the marginal propensity to save

c. the autonomous net tax multiplier

d. the simple spending multiplier

e. the marginal tax rate

6. A decrease in autonomous net taxes

a. increases GDP as much as an equal decrease in government purchases

b. increases GDP less than an equal increase in government purchases

c. decreases GDP more than an equal decrease in government purchases

d. changes GDP in an unpredictable manner

e. has no effect on GDP

7. The introduction of a $100 autonomous net tax in an economy with an MPC equal to 0.7 will, at each level of real GDP,

a. increase consumption by $100

b. decrease consumption by $100

c. increase consumption by $70

d. decrease consumption by $70

e. decrease consumption by $30

8. If the multiplier for autonomous government purchases equals 4, then it is true that the simple tax multiplier

a. equals –4

b. equals –3

c. always equals 1

d. is the same as the original multiplier

e. is invariably equal to 5

9. Of the following fiscal programs, which has the biggest effect, per dollar, on aggregate demand?

a. unemployment compensation during depressions

b. unemployment compensation during near-full employment

c. Aid to Families with Dependent Children

d. the space shuttle program

10. Of the following fiscal programs, which has the smallest effect, per dollar, on
aggregate demand?

a. defense spending

b. road construction

c. grants for scientific research and development

d. Social Security

e. government purchases of labor

11. Suppose both autonomous taxes and transfer payments increase by $50 billion. If the
MPC = 3/4, by how much does equilibrium real GDP demanded change?

a. $0

b. $50 billion

c. –$50 billion

d. $200 billion

e. –$200 billion

12. If the government wants to increase equilibrium by $100 billion through a change in autonomous net taxes, it could __________ autonomous net taxes by __________.

a. increase; $100 billion

b. decrease; $100 billion

c. decrease; $100 billion ´ MPC/(1 – MPC)

d. increase; $100 billion ´ MPC/(1 – MPC)

e. decrease; $100 billion ´ (1 – MPC)/MPC

13. To close a contractionary gap using fiscal policy, the government can

a. increase government spending by the size of the gap

b. decrease government spending by the size of the gap

c. increase government spending by more than the size of the gap

d. increase government spending by less than the size of the gap

e. decrease government spending by more than the size of the gap

14. A federal budget deficit occurs when

a. there is deflation

b. federal government purchases exceed net taxes

c. there is inflation

d. aggregate demand is greater than aggregate supply

e. aggregate supply is greater than aggregate demand

15. Which of the following is an appropriate fiscal policy to address the inflation that occurs when the economy is above potential GDP?

a. Decrease taxes to protect consumers from the effects of inflation.

b. Increase taxes to reduce aggregate demand.

c. Increase government spending to provide some of the goods consumers can no longer afford at the higher prices.

d. Decrease government spending so that the demand for money will fall.

e. Increase transfer payments to poor people, who are hurt the most by the inflation.

16. A $100 billion increase in government purchases has a greater effect on real GDP than a
$100 billion reduction in net taxes because

a. some of the income consumers gain from the tax reduction will be saved rather than spent

b. some of the income consumers gain from the tax reduction will be spent on services rather than products

c. some of the income consumers gain from the tax reduction will be spent on goods made in foreign countries

d. the consumers’ MPC is higher than the government’s

e. the consumers’ MPC is 1

17. Suppose that the economy has an expansionary gap of $1,000 and the MPC equals 0.8. If the short-run aggregate supply curve slopes upward, the government can close the gap if it decreases purchases by

a. $1,000

b. $800

c. $200

d. more than $200

e. less than $200

18. Which of the following best describes the concept of laissez-faire?

a. Government should not intervene in the economy.

b. Government should actively intervene in the economy

c. Government should intervene in the economy only to promote short-term economic stability.

d. Government should intervene in the economy only to maximize long-term growth rates.

e. Government should intervene in the economy only when the economy is not at full employment or there is substantial inflation.

Use the simple macro model outlined below to answer questions 1-4.

Y = C + I + G

C = 200 + 1/2 DI where DI = Y - T

I = 200

G = 250

T = 200

19. What is the equilibrium level of income?

20. If you needed to increase the equilibrium level of income by 200, by how much should you cut the taxes?

21. If government is to balance its budget by cutting its spending, what effect will such a policy have on real GDP?

22. If government raises its spending by 100 and at the same time raises the taxes by 100 also, what will be the effect on Y?