BR15B: Bridge: Fiscal Policy
Question 1
Which of the following is an example of an automatic stabilizer?
A. Governments debate implementing tax cuts when the economy is in a recession.
B. The amount of tax revenues collected rises when an economy is booming.
C. Low-income households lose their food stamp benefits when unemployment rises.
D. Spending on unemployment benefits falls when the economy enters a recession.
Hint
Automatic stabilizers are automatic spending and taxation changes that help smooth out the business cycle.Answer
B. The amount of tax revenues collected rises when an economy is booming. Automatic stabilizers are spending and taxation changes that automatically expand or contract so as to temper business cycle fluctuations without any overt action by the government. Automatic stabilizers include unemployment benefits and food stamps, which increase during downturns, and the income tax, which fluctuates with income.Question 2
Which of the following is not a program managed as part of fiscal policy?
A. Mortgage rates
B. Social Security
C. Unemployment benefits
D. Corporate taxes
Hint
Fiscal policy is the use of government spending and taxation to influence overall spending. Monetary policy consists of actions by the central bank to influence the money supply and thus interest rates, in turn impacting overall spending.Answer
A. Mortgage rates Fiscal policy refers to changes in government spending and taxation designed to affect aggregate expenditure. As Social Security, unemployment benefits, and corporate taxes all impact overall spending, they can be utilized as part of fiscal policy. Monetary policy refers to actions by the central bank to manipulate the money supply and thereby control interest rates. Mortgage rates is thus affected by monetary policy, not fiscal policy.Question 3
Appleville is a village that specializes in all forms of apple products. Suppose that each winter, when no apples are being produced, aggregate output falls below the long-run equilibrium output level. What type of fiscal policy might be most effective in correcting this problem?
A. reducing taxes in order to decrease aggregate demand
B. increasing taxes in order to increase aggregate demand
C. decreasing government spending in order to increase aggregate demand
D. increasing government spending in order to increase aggregate demand
Hint
Consider an aggregate demand and aggregate supply diagram and in which direction the aggregate demand curve would have to shift to move an economy toward long-run equilibrium output.Answer
D. increasing government spending in order to increase aggregate demand To address the downturn, the government can employ an expansionary fiscal policy either by increasing spending or reducing taxes. The result would be an expansion of aggregate demand, moving the economy back toward the long-run equilibrium output.Question 4
Which of the following is a common criticism of the use of fiscal policy?
A. Expansionary fiscal policy can help pull an economy out of a recession.
B. A government borrowing money to finance fiscal policy can crowd out investments.
C. Fiscal policy is often enacted too quickly, before the market is ready for it.
D. If no fiscal policy is used, the economy will never be able to correct itself, even partially.
Hint
Fiscal policy can be used to expand or contract the economy through adjusting taxes and spending at the federal level.Answer
B. A government borrowing money to finance fiscal policy can crowd out investments. Expansionary fiscal policy requires either a cut in taxes or an increase in government spending. Increasing government spending requires the government to borrow additional funds. This increase in demand for loans results in a rising interest rate, which then limits the ability of private investors to borrow funds.Question 5
Which of the following would be an example of expansionary fiscal policy?
A. a reduction in unemployment benefits
B. a reduction in government subsidies to farmers
C. a reduction in interest rates
D. a reduction in income taxes on low-income earners