Q: Suppose the government increases its purchases by $$10 billion in a closed economy where $$MPC = 0.8$$. What is the total change in output ($$\Delta Y$) if there is no crowding out? Use the multiplier formula.

$$\Delta Y = 5 \times 10 = 50$$ billion

Q: If the government reduces taxes by $$20$$ billion and $$MPC = 0.75$$, what is the initial effect on aggregate demand?

$$20 \text{ billion} \times 0.75 = 15 \text{ billion}$$ increase

Question 1

The diagram above shows three aggregate demand curves ($$AD_1$$, $$AD_2$$, $$AD_3) $$shifting to the right. Which of the following best explains the movement from $$AD_1 to$$ $$AD_2$$ and then to $$AD_3 in $$the context of fiscal policy and its macroeconomic effects?

Accepted Answer

The initial shift from $$AD_1 to$$ $$AD_2 is $$due to the direct increase in government purchases, while the further shift to $$AD_3 is $$explained by the multiplier effect, where increased income leads to further increases in consumption and aggregate demand.

Question 2

If the marginal propensity to consume (MPC) is 0.75, what is the value of the government spending multiplier in a closed economy? Use the formula $$K = \frac{1}{1 - MPC}.$$

Accepted Answer

$$K = \frac{1}{1 - 0.75} = 4$$

Question 3

Suppose the government increases its purchases by $$10 billion in a closed economy where $$MPC = 0.8$$. What is the total change in output ($$\Delta Y$) if there is no crowding out? Use the multiplier formula.

Accepted Answer

$$\Delta Y = 5 	imes 10 = 50$$ billion

Question 4

Which of the following best describes the crowding-out effect on investment?

Accepted Answer

An increase in government spending raises interest rates, which reduces private investment and partially offsets the increase in aggregate demand.

Question 5

In an open economy with a flexible exchange rate, what is the likely effect of expansionary fiscal policy on net exports?

Accepted Answer

Net exports decrease due to an appreciation of the domestic currency, which makes exports more expensive and imports cheaper.

Question 6

Given $$MPC = 0.75$$ and $$MPI = 0.25 in an $$open economy, what is the value of the government purchases multiplier? Use the formula $$K = \frac{1}{1 - MPC + MPI}.$$

Accepted Answer

$$K = \frac{1}{1 - 0.75 + 0.25} = 2$$

Question 7

Which of the following is an example of an automatic stabilizer in fiscal policy?

Accepted Answer

An increase in unemployment insurance payments during a recession.

Question 8

If the government reduces taxes by $$20$$ billion and $$MPC = 0.75$$, what is the initial effect on aggregate demand?

Accepted Answer

$$20 	ext{ billion} 	imes 0.75 = 15 	ext{ billion}$$ increase

Question 9

Why might the total effect of a tax cut on aggregate demand be smaller than the total effect of an equal increase in government purchases?

Accepted Answer

Because part of the tax cut is saved by consumers, so not all of it is spent and added to aggregate demand.

Question 10

Which of the following best explains why fiscal policy may not always stabilize the economy as intended?

Accepted Answer

There are significant time lags in the implementation of fiscal policy, so the effects may occur after economic conditions have changed.

Question 11

Suppose the Bank of Canada maintains a fixed interest rate while the government increases spending. What is the likely effect on aggregate demand compared to a situation where the Bank takes no action?

Accepted Answer

Aggregate demand will increase by a larger amount if the Bank maintains a fixed interest rate.

Question 12

If the government follows a strict balanced budget rule during a recession, what is the likely effect on the severity of the recession?

Accepted Answer

The recession will become more severe because the government would need to raise taxes or cut spending, reducing aggregate demand further.

Question 13

Which of the following best describes the effect of a flexible exchange rate as an automatic stabilizer in an open economy?

Accepted Answer

A fall in net exports causes the domestic currency to depreciate, which increases net exports and helps stabilize aggregate demand.

Question 14

Which of the following statements about the multiplier effect is correct?

Accepted Answer

The multiplier effect means that an initial change in spending leads to a larger total change in aggregate demand.

Question 15

If the marginal propensity to consume (MPC) increases, what happens to the value of the multiplier in a closed economy?

Accepted Answer

The multiplier increases because more of each additional dollar of income is spent.

Question 16

Which of the following is NOT a reason why government spending automatically increases during a recession?

Accepted Answer

The government automatically increases infrastructure spending.

Question 17

Suppose the government increases spending by $$5$$ billion in a closed economy with $$MPC = 0.6. $$What is the total change in output ($$\Delta Y$$)?

Accepted Answer

$$\Delta Y = \frac{1}{1 - 0.6} 	imes 5 = 2.5 	imes 5 = 12.5$$ billion

Question 18

Which of the following best describes the effect of a tax cut in an open economy with a flexible exchange rate?

Accepted Answer

A tax cut increases aggregate demand, but also causes the currency to appreciate, reducing net exports and offsetting some of the initial increase.

The Influence of Fiscal Policy on Aggregate Demand

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