Q: Suppose the government increases its spending by $200 billion and the marginal propensity to consume (MPC) is 0.75. If there are no taxes or imports, what is the total increase in GDP using the simple spending multiplier?

$$200 \div (1 - 0.75) = 800$$ \text{ billion} $

Q: Suppose the government implements a $$100 billion tax cut. If the MPC is 0.75 and the tax multiplier is -1.875$, what is the expected change in equilibrium GDP?

$$100 \times 1.875 = 187.5$$ \text{ billion} $

Question 1

Which of the following best describes the primary goal of fiscal policy?

Accepted Answer

To shift aggregate demand in a desired direction through government spending and taxation

Question 2

Suppose the government increases its spending by $200 billion and the marginal propensity to consume (MPC) is 0.75. If there are no taxes or imports, what is the total increase in GDP using the simple spending multiplier?

Accepted Answer

$$200 \div (1 - 0.75) = 800$$ 	ext{ billion} $

Question 3

Why is the tax multiplier smaller than the government spending multiplier?

Accepted Answer

Because tax changes only affect disposable income, and not all of the change is spent

Question 4

If the marginal propensity to consume (MPC) is 0.75 and the income tax rate is 20%, what is the formula for the spending multiplier?

Accepted Answer

$$\frac{1}{1 - b(1 - t)}$$ where $$b = 0.75$$ and $$t = 0.20$$

Question 5

Which of the following is an example of an automatic stabilizer?

Accepted Answer

Personal income tax and unemployment insurance

Question 6

A supply-side tax cut is primarily intended to:

Accepted Answer

Raise aggregate supply by improving incentives to work, save, and invest

Question 7

Suppose the government implements a $$100 billion tax cut. If the MPC is 0.75 and the tax multiplier is -1.875$, what is the expected change in equilibrium GDP?

Accepted Answer

$$100 	imes 1.875 = 187.5$$ 	ext{ billion} $

Question 8

Which of the following is NOT a criticism of supply-side tax cuts?

Accepted Answer

They immediately increase aggregate supply

Question 9

If the government wants to slow down an overheating economy, which combination of fiscal policies could it use?

Accepted Answer

Reduce government spending, increase taxes, reduce transfer payments

Question 10

Given the following consumption function $$C = 300 + 0.75D_I$$, disposable income $$D_I = Y - T$$, and a tax function $$T = 0.20Y$$, what is the equation for consumption in terms of $$Y$$?

Accepted Answer

$$C = 300 + 0.75(0.80Y)$$

Question 11

Why does a variable tax, such as an income tax, reduce the size of the multiplier?

Accepted Answer

Because as income rises, more is taken out in taxes, leaving less for consumption

Question 12

Which of the following equations represents the equilibrium condition in the presence of taxes and imports?

Accepted Answer

$$Y = C + I + G + (X - IM)$$

Question 13

If the government spending multiplier is 2.5 and the tax multiplier is -1.875, what is the difference between the two multipliers?

Accepted Answer

Question 14

Which of the following is a reason why the oversimplified multiplier formula may overstate the true multiplier?

Accepted Answer

It ignores variable imports, price-level changes, and income taxes

Question 15

A government planner faces which of the following challenges when designing fiscal policy?

Accepted Answer

Uncertain knowledge of the multiplier, full-employment GDP, and inflationary implications

Question 16

Which of the following best describes the effect of government transfer payments on aggregate demand?

Accepted Answer

They function as negative taxes, increasing disposable income and aggregate demand

Question 17

If the government wants to stimulate output but prefers a smaller government sector, which fiscal policy would it likely choose?

Accepted Answer

Reduce taxes

Question 18

Which of the following is a likely short-run effect of supply-side tax cuts?

Accepted Answer

Aggregate demand increases more quickly than aggregate supply

Question 19

Suppose the government increases both government spending and taxes by $500 billion. If the spending multiplier is larger than the tax multiplier, what is the net effect on equilibrium GDP?

Accepted Answer

Equilibrium GDP will increase

Question 20

Which of the following tax policies would supply-side economists most likely advocate to increase aggregate supply?

Accepted Answer

Reduce taxes on capital gains and corporate income

Managing Aggregate Demand: Fiscal Policy – Study Notes

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