Chapter 15
Practice Quiz Tutorial
Fiscal Policy
©2004 South-Western
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1. Contractionary fiscal policy is deliberate
government action to influence aggregate
demand and the level of real GDP through
a. expanding and contracting the money
supply.
b. encouraging business to expand or contract
investment.
c. regulation of net exports.
d. decreasing government spending or
increasing taxes.
D. The money supply is under control of the
Federal Reserve and not Congress.
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2. The spending multiplier is defined as
a. 1 / (1 - marginal propensity to consume).
b. 1 / (marginal propensity to consume)
c. 1 / (1 - marginal propensity to save).
d. 1 / (marginal propensity to consume +
marginal propensity to save).
A. The spending multiplier is also defined
as 1/MPS.
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3. If the marginal propensity to consume
(MPC) is 0.60, the value of the spending
multiplier is
a. 0.4
b. 0.6
c. 1.5
d. 2.5.
D. Spending multiplier = 1 / (1 - MPC) =
1 / (1 - 0.60) = 1 / 40/100 = 5 / 2 = 2.5
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4. Assume the economy is in recession and real GDP is
below full employment. The marginal propensity to
consume (MPC) is 0.80, and the government increases
spending by $500 billion. As a result, aggregate
demand will rise by
a. zero.
b. $2,500 billion.
c. more than $2,500 billion.
d. less than $2,500 billion.
B. Change in aggregate demand (Y) = initial change in
government spending (G) x spending multiplier.
Spending multiplier = 1 / (1 - MPC) = 1 / (1 - 0.80) = 1 /
20/100 = 5
Y = $500 billion x 5
Y = $2,500 billion
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5. Mathematically, the value of the tax
multiplier in terms of the marginal propensity
to consume (MPC) is given by the formula
a. MPC  1.
b. (MPC  1) MPC
c. 1 / MPC
d. 1  [1 / (1  MPC)].
D. The tax multiplier is also stated as Tax
multiplier = 1 - spending multiplier.
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6. Assume the marginal propensity to consume
(MPC) is 0.75 and the government increases
taxes by $250 billion. The aggregate demand
curve will shift to the
a. left by $1,000 billion.
b. right by $1,000 billion.
c. left by $750 billion.
d. right by $750 billion.
C. The tax multiplier is -3 (1 - spending
multiplier) and -3 times $250 billion equals a
$750 billion decrease. The movement is left
because consumers have less money to spend.
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7. If no fiscal policy changes are made, suppose the
current aggregate demand curve will increase
horizontally by $1,000 billion and cause inflation. If
the marginal propensity to consume (MPC) is 0.80,
federal policy-makers could follow Keynesian
economics and restrain inflation by
a. decreasing government spending by $200 billion.
b. decreasing taxes by $100 billion.
c. decreasing taxes by $1,000 billion.
d. decreasing government spending by $1,000 billion.
A. Change in government spending (G) x spending
multiplier = change in aggregate demand, rewritten:
G = change in aggregate demand / spending multiplier
Spending multiplier = 1 / (1-MPC) = 1 / (1-0.80) = 1 / 20/100 =
5
G = -$1,000/5, G = -$200 billion.
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8. If no fiscal policy changes are implemented, suppose
the future aggregate demand curve will exceed the
current aggregate demand curve by $500 billion at any
level of prices. Assuming the marginal propensity to
consume (MPC) is 0.80, this increase in aggregate
demand could be prevented by
a. increasing government spending by $500 billion.
b. increasing government spending by $140 billion.
c. decreasing taxes by $40 billion.
d. increasing taxes by $125 billion.
D. Change in taxes (T) x tax multiplier = change in aggregate
demand, rewritten:
Tax multiplier = 1 - spending multiplier
Spending multiplier = 1 / (1-MPC) = 1 / 1-0.80) = 1 / 20/100 = 5
Tax multiplier = 1 - 5 = -4, T = $600 billion/5, T = -$200
billion
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9. Suppose inflation is a threat because the
current aggregate demand curve will increase
by $600 billion at any price level. If the
marginal propensity to consume (MPC) is 0.75,
federal policy-makers could follow Keynesian
economics and restrain inflation by
a. decreasing taxes by $600 billion.
b. decreasing transfer payments by $200
billion.
c. increasing taxes by $200 billion.
d. increasing government spending by $150
billion.
C. 3 x $200 billion = $600 billion.
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10. If no fiscal policy changes are implemented, suppose
the aggregate demand curve will shift and exceed the
current aggregate demand curve by $900 billion at any
level of prices. Assuming the marginal propensity to
consume is (MPC) 0.90, this increase in aggregate
demand could be prevented by
a. increasing government spending by $500 billion.
b. increasing government spending by $140 billion.
c. decreasing taxes by $40 billion.
d. increasing taxes by $100 billion.
D. The tax multiplier is 9 (1 - spending multiplier of
10). If taxes are increased by $100 billion spending
will go down by $900 billion and aggregate
demand shifts leftward by this amount at any price
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level.
11. Which of the following is not an automatic
stabilizer?
a. Defense spending.
b. Unemployment compensation benefits.
c. Personal income taxes.
d. Welfare payments.
A. Defense spending does not automatically
change levels as real GDP changes.
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12. Supply-side economics is most closely
associated with
a. Karl Marx.
b. John Maynard Keynes.
c. Milton Friedman.
d. Ronald Reagan.
D. The most familiar supply-side economic
policy of the Reagan administration was
the tax cuts implemented in 1981.
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13. Which of the following statements is true?
a. A reduction in tax rates along the downwardsloping portion of the Laffer curve would increase
tax revenues.
b. According to supply-side fiscal policy, lower tax
rates would shift the aggregate demand curve to
the right, expanding the economy and creating
some inflation.
c. The presence of the automatic stabilizers tends to
destabilize the economy.
d. To combat inflation, Keynesians recommend
lower taxes and greater government.
A.
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The Laffer Curve
R
Federal Tax Revenue
Rmax
B
C
A Federal Tax Rate
0
Tmax
D
T 100%
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END
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