Multiple-Choice Review Questions

1. Fiscal policy is
(A) increases in taxes to fight recessions.
(B) decreases in taxes to fight inflations.
(C) changes in government spending and taxes to fight recessions or inflations.
(D) federal deficits.
(E) federal surpluses.

2. A federal deficit occurs when
(A) exports exceed imports.
(B) imports exceed exports.
(C) federal tax collections exceed spending.
(D) federal spending exceeds federal tax revenues.
(E) the federal government spends less than last year.

3. The appropriate fiscal policy to remedy a recession is
(A) for the federal government to run a deficit.
(B) for the federal government to run a surplus.
(C) increased taxes and government spending.
(D) decreased government spending and taxes.
(E) increased taxes and reduced government spending.

4. The appropriate fiscal policy to remedy inflation is
(A) for the federal government to run a deficit.
(B) for the federal government to run a surplus.
(C) increased taxes and government spending.
(D) decreased government spending and taxes.
(E) decreased taxes and increased government spending.

5. To close a recessionary gap
(A) the aggregate demand curve should be shifted to the right.
(B) the aggregate demand curve should be shifted to the left.
(C) the aggregate supply curve should be shifted to the right.
(D) the aggregate supply curve should be shifted to the left.
(E) prices should be raised.

6. To close an inflationary gap
(A) the aggregate demand curve should be shifted to the right.
(B) the aggregate demand curve should be shifted to the left.
(C) the aggregate supply curve should be shifted to the left.
(D) government spending should be increased.
(E) tax collections should be decreased.

7. One drawback of using fiscal policy to close a recessionary gap is that
(A) unemployment will rise.
(B) taxes will have to be raised.
(C) the equilibrium price level will rise.
(D) government spending on important programs will have to be cut.
(E) equilibrium output will fall.

8. Suppose government spending decreases by $8 million and the MPC = 0.75. If there is a full multiplier effect, then this will cause aggregate demand to
(A) increase by $8 million.
(B) decrease by $8 million.
(C) increase by $6 million.
(D) decrease by $6 million.
(E) decrease by $32 million.

9. Suppose the government decreases taxes by $8 million and the MPC = 0.75. If there is a full multiplier effect, then this will cause aggregate demand to
(A) increase by $8 million.
(B) decrease by $8 million.
(C) increase by $6 million.
(D) decrease by $6 million.
(E) increase by $24 million.

10. Crowding out is when
(A) fiscal policy outperforms monetary policy.
(B) interest rates fall due to government borrowing.
(C) government borrowing raises interest rates, causing cuts in business spending.
(D) rising interest rates cause cuts in government spending.
(E) falling interest rates cause cuts in government spending.

11. Automatic, or built-in, stabilizers cause government tax collections to ______ during recessions and ______ during expansions.
(A) increase; increase
(B) increase; decrease
(C) remain unchanged; remain unchanged
(D) decrease; decrease
(E) decrease; increase

12. A simultaneous increase in government spending of $200 and an increase in income tax collections of $200 ______ aggregate demand by ______. Assume an MPC of 0.8.
(A) does not affect; any amount
(B) increases; $200
(C) decreases; $200
(D) increases; $160
(E) increases; $1,000

13. Which of the following would cause unemployment and prices to rise?
(A) A climate event that wipes out a portion of the economy’s natural resources
(B) An increase in the money supply
(C) An increase in consumer confidence
(D) An increase in taxes
(E) A decrease in taxes

14. If government spending is reduced, then unemployment ______ and inflation ______.
(A) increases; increases
(B) increases; decreases
(C) remains unchanged; remains unchanged
(D) decreases; decreases
(E) decreases; increases

15. An income tax cut may not affect the macroeconomy very much if
(A) consumers spend a good portion of their tax reduction on domestic goods.
(B) consumers spend a good portion of their tax reduction on foreign goods.
(C) the tax cut is permanent.
(D) consumers are optimistic about the economic future.
(E) the Fed simultaneously increases the money supply.

Free-Response Review Questions

1. Draw an aggregate supply/aggregate demand diagram that portrays a recessionary gap. Be sure to label the axes of your diagram and the aggregate demand curve, the short-run aggregate supply curve, and the long-run aggregate supply curve.

2. Should government spending be increased or decreased to close a recessionary gap? Show how this change in government spending is reflected in the diagram drawn for question 1.

3. If the government does nothing in the face of a recessionary gap, would wages and resources prices be expected to increase or decrease in the long run? Explain. Which curve of the aggregate supply/aggregate demand model would shift which way once wages and resource prices changed?