Deck 11: Fiscal Policy: The Keynesian View and the Historical Development of Macroeconomics

Question 1

When aggregate demand exceeds current output, Keynesian analysis indicates that

A) unplanned inventory accumulation will cause output to rise.
B) unplanned inventory accumulation will cause output to fall.
C) unplanned inventory reductions will cause output to rise.
D) unplanned inventory reductions will cause output to fall.

Answer 1

unplanned inventory reductions will cause output to rise.

Question 2

The multiplier effect refers to the fact that a change in spending (aggregate demand) will

A) increase the money supply.
B) cause prices to rise by some multiple of the initial increase in spending.
C) cause nominal output to rise by some multiple of the initial increase in spending.
D) reduce prices by some multiple of the increase in spending.

Answer 2

cause nominal output to rise by some multiple of the initial increase in spending.

Question 3

According to the Keynesian view, if purchasers buy more goods and services than businesses expect,

A) the inventories of firms would decline, and the firms would expand output in order to restore their inventories to desired levels.
B) the inventories of firms would increase, and the firms would reduce output until inventories were cut back to the desired level.
C) the current level of income would persist in the future.
D) firms would reduce their investment, and the economy would fall into a recession.

Answer 3

the inventories of firms would decline, and the firms would expand output in order to restore their inventories to desired levels.

Question 4

The 1930s were a period of

A) strong economic expansion and rapid growth of real output.
B) high rates of inflation coupled with a low rate of unemployment.
C) depressed economic conditions and prolonged high rates of unemployment.
D) strong growth of real output even though the general level of prices was declining.

Question 5

Mathematically, the marginal propensity to consume is

A) consumption divided by income.
B) the change in consumption divided by the change in income.
C) income divided by consumption.
D) the change in income divided by the change in consumption.

Question 6

Within the framework of the Keynesian model, if spending is abnormally low,

A) the economy will be in equilibrium at full employment, but inflation will be high.
B) equilibrium output will be less than the full-employment rate of output.
C) the equilibrium output rate will exceed the economy's full-employment capacity.
D) the actual rate of unemployment will be less than the natural rate of unemployment.

Question 7

As the marginal propensity to consume (MPC) decreases, the spending multiplier

A) increases.
B) decreases.
C) remains constant.
D) becomes indefinable.

Question 8

Prior to the Great Depression, most economists believed that a recessionary downturn would be reversed by

A) higher wages that would stimulate aggregate demand and reduce unemployment.
B) lower wages that would increase the quantity of labor demanded and reduce unemployment.
C) an expansionary monetary policy on the part of the Federal Reserve System.
D) an increase in government spending that would stimulate aggregate demand and employment.

Question 9

Within the Keynesian model, when total spending is less than the full-employment level of output, firms will

A) continue to produce the current level of output.
B) cut production to reduce their inventory accumulation.
C) expand production to reduce their inventory accumulation.
D) cut production to build inventories.

Question 10

In the Keynesian view, equilibrium takes place when

A) the real and nominal interest rates are equal.
B) the level of total spending in the economy is equal to current output.
C) current output is equal to the economy's long-run potential.
D) the money supply is growing at a constant rate.

Question 11

As the marginal propensity to consume (MPC) increases, the spending multiplier

A) increases.
B) decreases.
C) remains constant.
D) becomes indefinable.

Question 12

The marginal propensity to consume is defined as the

A) fraction of total income not spent on consumption.
B) proportion of any change in income that is spent on consumption.
C) fraction of total income spent on consumption.
D) fraction of a change in income that is saved.

Question 13

Keynesian analysis indicates that an unexpected decline in aggregate demand will lead to

A) a reduction in inventories and an expansion in employment.
B) an increase in inventories and a reduction in output.
C) lower interest rates, which will stimulate aggregate demand and keep the economy at full employment.
D) a lower price level, which will quickly guide the economy to full-employment equilibrium.

Question 14

Keynes rejected the view that lower wages would direct a recessionary economy back to full employment because

A) lower wages would cause the central bank to reduce the money supply and thereby prolong the recession.
B) lower wages would stimulate inflation and thereby prolong the recession.
C) market forces would quickly direct an economy back to full employment.
D) powerful trade unions and large corporations made wages highly inflexible.

Question 15

The expenditure multiplier indicates that

A) changes in investment, government, or consumption spending can trigger much larger changes in output.
B) an increase in saving will cause output to rise by a multiple of the additional saving.
C) a market economy will be more stable than classical economists thought.
D) the marginal propensity to consume is greater than one.

Question 16

The Keynesian model provided an explanation for

A) the prolonged unemployment of the 1930s.
B) the double-digit inflation rates of the 1970s.
C) the high unemployment rates of the 1970s.
D) the high inflation rates of the 1930s.

Question 17

Within the framework of the Keynesian model,

A) changes in output rather than changes in prices direct the economy to equilibrium.
B) changes in prices rather than changes in output direct the economy to equilibrium.
C) changes in interest rates and resource prices will direct the economy to equilibrium.
D) the economy will continually be in equilibrium.

Question 18

Prior to the time of John Maynard Keynes, most economists stressed that

A) low levels of aggregate demand would lead to prolonged periods of unemployment.
B) market economies were inherently unstable because of fluctuating aggregate demand.
C) market adjustments would automatically direct an economy to full employment within a relatively brief period of time.
D) budget deficits and surpluses were necessary for the control of economic fluctuations.

Question 19

Keynesian economists believed that the prolonged unemployment of the 1930s was the result of

A) the sharp reduction in the supply of money during 1929-1933 and another monetary contraction in 1938.
B) the high interest rates of the 1930s.
C) the double-digit inflation of the 1930s.
D) insufficient aggregate demand and the failure of market forces to direct the  economy back to full employment.

Question 20

According to the Keynesian view, the prolonged unemployment of the Great Depression

A) was surprising because Keynesians believed that wage rates would decline and direct the economy to full employment.
B) was surprising because Keynesians believed that lower interest rates would direct the economy to full employment.
C) resulted because the total expenditures on goods and services were less than the full-employment rate of output.
D) resulted because the federal government ran large budget deficits during the 1930s.

Question 21

If the government increases its spending, which of the following would tend to reduce the size of the multiplier?

A) higher taxes for the finance of the additional spending
B) higher interest rates as the result of additional borrowing to finance the spending
C) the flow of the spending into sectors where the unemployment rate is low
D) all of the above

Question 22

Within the Keynesian model, if the marginal propensity to consume is 0.8, which of the following is true?

A) When consumption increases by $5, income increases by $1.
B) When consumption increases by $1, saving increases by $5.
C) When investment increases by $1, income increases by $5.
D) When investment increases by $1, saving increases by $5.

Question 23

Which of the following provides the best information about the direction of the government's fiscal policy?

A) changes in the Fed's holdings of U.S. government securities
B) changes in the reserve requirements of the Federal Reserve
C) changes in the nation's trade balance
D) changes in the size of the federal government's budget deficit or surplus

Question 24

The marginal propensity to consume (MPC) is

A) consumption expenditures divided by saving.
B) consumption expenditures divided by disposable income.
C) consumption expenditures divided by personal income.
D) additional consumption expenditures divided by additional disposable income.

Question 25

When the unemployment rate is low, the impact of additional spending on real output will

A) be larger than when the unemployment rate is high.
B) be smaller than when the unemployment rate is high.
C) be the same as when the unemployment rate is high.
D) place downward pressure on the general level of prices, leading to deflation.

Question 26

Keynesian analysis implies that potential output and price stability can be achieved if

A) the federal budget is balanced annually.
B) marginal tax rates are kept low so the incentive to produce will be strong.
C) aggregate demand is equal to the economy's full-employment rate of output.
D) current saving exceeds the level of investment.

Question 27

In the Keynesian aggregate expenditure model, the equilibrium level of income is achieved when

A) actual saving equals actual investment.
B) planned aggregate expenditures equal total output.
C) consumption equals income times the marginal propensity to consume.
D) the marginal propensity to consume equals planned output.

Question 28

During normal times, if the marginal propensity to consumer is 3/4, and the government borrows $10 billion in order to increase spending by that amount, real output will expand by

A) more than $40 billion, because both the additional borrowing and the additional spending will stimulate real output.
B) $40 billion, because the net multiplier will be 4.
C) less than $40 billion, because the additional borrowing will place upward pressure on real interest rates, weakening the impact of the multiplier.
D) $10 billion, because during normal times, the government can borrow funds without any increase in interest rates.

Question 29

According to the Keynesian view, an unanticipated reduction in spending will

A) increase the demand for goods and services.
B) raise business inventories and lead to a decline in output.
C) lead to lower interest rates, which will stimulate aggregate demand and keep the economy at full employment.
D) lead to a lower price level, which will quickly guide the economy to full-employment equilibrium.

Question 30

When there are few unemployed resources, additional spending will tend to

A) flow directly to the unemployed resources, so that the multiplier can be maintained at 1/1-mpc.
B) increase the marginal propensity to consume, and thereby increase the size of the multiplier.
C) increase the demand for resources and drive prices downward, increasing the size of the multiplier.
D) bid resources away from other activities and drive prices upward, reducing the size of the multiplier.

Question 31

When the federal government is running a budget deficit,

A) government revenues exceed government expenditures.
B) government expenditures exceed government revenues.
C) the economy must be in an economic recession.
D) the size of the national debt will decline.

Question 32

The primary tool of fiscal policy is

A) the money supply.
B) the stock market.
C) the federal budget.
D) regulation of the bond market.

Question 33

The multiplier principle is important because it

A) was central to economic theory before Keynes.
B) implies that investment will help stabilize the economy.
C) shows why small shifts in investment have a powerful influence on national income.
D) illustrates why a small change in income causes a large change in saving.

Question 34

During normal times, the multiplier effect of an increase in government spending financed by taxes will be

A) strengthened, if the additional spending flows into sectors of the economy where the unemployment rates are low.
B) weakened by an offsetting reduction in spending due to the higher taxes.
C) unaffected, as long as the higher taxes are in the future.
D) strengthened, if corporate tax rates are increased and personal tax rates remain unchanged.

Question 35

The larger the marginal propensity to consume,

A) the larger the multiplier.
B) the larger the marginal propensity to save.
C) the higher the income level of the economy.
D) the smaller the change in income derived from a given change in government spending.

Question 36

Within the Keynesian model, the multiplier effect tends to

A) smooth out the up- and down- swings of the business cycle.
B) promote price stability.
C) magnify small changes in spending into much larger changes in output and employment.
D) reduce the impact of an increase in investment on output and employment.

Question 37

A balanced budget is present when

A) the economy is at full employment.
B) the actual level of aggregate spending equals the planned level of spending.
C) public sector spending equals private sector spending.
D) government revenues equal government expenditures.

Question 38

The consumption function shows the relationship between

A) planned consumption expenditures and disposable income.
B) permanent income and savings.
C) business inventory and real GDP.
D) aggregate demand and aggregate consumption.

Question 39

When an economy is operating well below its full-employment capacity and the marginal propensity to consume is 3/4, a $10 billion increase in investment will cause the equilibrium income to rise by

A) $5 billion.
B) $10 billion.
C) $20 billion.
D) $40 billion.

Question 40

If the federal government is running a budget surplus,

A) its expenditures must be greater than its revenues.
B) the supply of money will decline.
C) it will be able to reduce its outstanding debt.
D) the U.S. Treasury will have to borrow additional funds in order to cover the surplus.

Question 41

Why does a tax change affect aggregate demand?

A) A tax change alters saving by an equal amount.
B) A tax change alters imports and net exports.
C) A tax change alters government spending by an equal amount.
D) A tax change alters disposable income and consumption spending.

Question 42

If the economy is experiencing inflationary boom, and the government lowers taxes in an effort to balance the budget, the Keynesian model indicates the likely effect will be to

A) counteract inflation.
B) reduce the trade deficit.
C) continue inflationary pressures.
D) increase unemployment.

Question 43

Federal budget deficits generally grow during recessions because

A) both tax revenues and transfer payments decrease.
B) both tax revenues and transfer payments increase.
C) tax revenues decrease while transfer payments increase.
D) tax revenues increase while transfer payments decrease.
E) tax revenues decrease but transfer payments are unchanged.

Question 44

Keynesian analysis suggests that a planned budget surplus

A) will affect aggregate demand only if the money supply decreases by the size of the surplus.
B) will stimulate both consumption and income.
C) will stimulate output and employment.
D) is proper during periods of inflation but may increase unemployment if timed improperly.

Question 45

Fiscal policy designed to increase aggregate demand during economic downturns and decrease aggregate demand during economic booms is called

A) business cycle fiscal policy.
B) new classical fiscal policy.
C) supply-side fiscal policy.
D) countercyclical fiscal policy.

Question 46

If the government owes $15.0 trillion and then borrows $900 billion more this year, this leads to

A) a debt of $900 billion and a deficit of $15.9 trillion.
B) a debt of $15.9 trillion and a deficit of $900 billion.
C) a debt of $14.1 trillion and a deficit of $900 billion.
D) a debt of $15.0 trillion and a deficit of $14.1 trillion.
E) a debt of $15.9 trillion and a deficit of zero.

Question 47

If the economy is experiencing less than full-employment, the Keynesian model recommends that the government

A) do nothing to stimulate the economy.
B) undertake expansionary fiscal policy to stimulate aggregate demand.
C) undertake expansionary fiscal policy to stimulate aggregate supply.
D) balance the budget to stimulate aggregate demand.

Question 48

If Congress votes to increase government purchases and at the same time decrease personal income taxes, they

A) have decided to balance the federal budget.
B) have voted for the proper policy to counteract a recession.
C) have voted for the proper policy to counteract inflation and an economic boom.
D) are trying to achieve a federal budget surplus.

Question 49

The Keynesian analysis of fiscal policy implies that

A) fiscal policy should generally be expansionary except during periods of economic recession.
B) fiscal policy should generally be restrictive except during inflationary booms.
C) the federal budget should be balanced annually except during war.
D) the federal budget should be used to maintain aggregate demand at a level consistent with full employment.

Question 50

Which of the following would decrease the size of a federal budget deficit?

A) a recession
B) an increase in defense spending
C) growth in real GDP
D) a decrease in tax revenues
E) an increase in transfer payments

Question 51

Within the framework of the Keynesian model, which of the following would most likely occur if the federal government increased its spending and enlarged the size of the budget deficit during a period of full employment?

A) The rate of inflation would decline.
B) The rate of inflation would rise.
C) A recession would develop.
D) Interest rates would fall.

Question 52

According to the Keynesian view, if real GDP is slowing and the economy appears to be headed for a recession, a reduction in tax rates is

A) highly appropriate because it will stimulate aggregate demand and, thereby, help to strengthen the economy.
B) highly inappropriate because it will either reduce the size of the budget surplus or increase the size of the deficit.
C) not very important because the "demand stimulus effects" of the tax cut will be largely offset by additional borrowing.
D) not very important because the "demand stimulus effects" of lower current taxes will be largely offset by the expectation of higher taxes in the future.

Question 53

Which of the following best expresses the central idea of countercyclical fiscal policy?

A) Planned deficits are experienced during economic booms and planned surpluses during economic recessions.
B) The balanced-budget approach is the proper criterion for determining annual budget policy.
C) Actual deficits should equal actual surpluses during a period of deflation.
D) Deficits are planned during economic recessions, and surpluses are utilized to restrain inflationary booms.

Question 54

The government is pursuing an expansionary fiscal policy if it

A) decreases government spending and increases taxes.
B) increases government spending or increases taxes.
C) decreases government spending or reduces taxes.
D) increases government spending and/or reduces taxes.

Question 55

According to the Keynesian view, if policy makers thought the economy was about to fall into a recession, which of the following would be most appropriate?

A) a change in government spending and taxation that will lead to a budget surplus
B) a planned increase in the budget deficit
C) reducing government expenditures
D) balancing the budget

Question 56

Changes in government spending and/or taxes as the result of legislation, is called

A) open market operations of the Federal Reserve.
B) discretionary fiscal policy.
C) balanced budget operations.
D) discretionary monetary policy.

Question 57

The prevailing budget philosophy prior to Keynes called for a balanced budget. Keynes argued that the government should not balance its budget but instead have budget deficits during

A) economic booms.
B) during periods of peace but surpluses during periods of war.
C) periods of inflation.
D) economic recessions.

Question 58

When an economy is operating below its potential capacity, Keynesian economists argue that

A) taxes should be raised if the government is currently running a budget deficit.
B) taxes should be lowered but only if the government is running a budget surplus.
C) the government should cut taxes and/or increase expenditures in order to stimulate aggregate demand.
D) both a and b are correct.
E) all of the above are correct.

Question 59

According to the Keynesian view, if an economy was operating at long-run equilibrium, an increase in government expenditures (holding taxes constant) would

A) be inflationary.
B) lead to a recession.
C) lower the real rate of interest.
D) reduce the size of the national debt.

Question 60

If the federal government is running a budget deficit,

A) the national debt will decline.
B) it will have to either raise taxes or reduce expenditures next year.
C) the U.S. Treasury will finance the deficit by issuing additional bonds.
D) the supply of money will increase and the general level of prices will rise.

Question 61

Which of the following is a major deficiency of fiscal policy as a stabilization tool?

A) Congress is reluctant to make changes in either taxes or expenditures.
B) The Constitution requires the president to submit and Congress to pass a balanced budget.
C) Both political and economic factors make it unlikely that changes in fiscal policy will be timed correctly.
D) A change in fiscal policy exerts major effects on the economy quickly.

Question 62

According to the Keynesian view, which of the following would most likely stimulate real output if an economy were in a recession?

A) a decrease in tax rates
B) an increase in tax rates
C) a reduction in government expenditures
D) a budget surplus

Question 63

Long lags make discretionary policy less effective because

A) by the time the impact of a policy is felt, the problem may have been corrected by market forces.
B) it is easier to forecast an expansion than a recession.
C) it is easier to forecast a recession than an expansion.
D) automatic stabilizers are subject to longer lags than are discretionary policies.

Question 64

If an economy is experiencing both full employment and price stability, within the Keynesian model, a major tax reduction probably would cause

A) an increase in unemployment in the near future.
B) an increase in the general level of prices unless government expenditures are also reduced.
C) an increase in the interest rate since individuals will reduce their savings in response to the tax cut.
D) a decrease in consumption unless the expected budget deficit is financed by selling bonds to foreigners.

Question 65

Because of automatic stabilizers, government budget deficits are

A) positive during both expansions and contractions.
B) negative during both expansions and contractions.
C) zero if averaged out over the entire business cycle.
D) larger during expansions and smaller during contractions.
E) smaller during expansions and larger during contractions.

Question 66

The main reason that the deficit grows in a recession is that

A) the government reacts quickly and adjusts taxes to compensate.
B) monetary policy that targets interest rates causes the costs of borrowing to fall.
C) the deficit causes the recession, and reducing the deficit cures the recession.
D) many forms of taxes act as automatic stabilizers.

Question 67

Automatic stabilizers will shift the government budget toward

A) a surplus during both expansions and contractions.
B) a deficit during both expansions and contractions.
C) a surplus during an expansion and a deficit during a contraction.
D) a surplus during a contraction and a deficit during an expansion.

Question 68

Unemployment compensation payments

A) rise during a recession and thereby help stimulate consumption.
B) rise during a recession and thereby retard consumption.
C) rise during economic expansion and thereby help stimulate consumption.
D) rise during economic expansion and thereby retard consumption.

Question 69

In the midst of the Great Depression in 1932, Congress and the Hoover administration increased tax rates substantially. According to the Keynesian view, this tax increase was

A) inappropriate because it would depress economic activity and lead to further increases in unemployment.
B) appropriate because it would lead to a significant increase in the money supply and, thereby, increase employment.
C) inappropriate because it would decrease the money supply and, thereby, prolong the Depression.
D) appropriate because it would stimulate economic activity and help end the Depression.

Question 70

The distinction between discretionary fiscal policy and the use of automatic stabilizers is that

A) only discretionary fiscal policy can stimulate the economy.
B) only automatic stabilizers can stimulate the economy.
C) discretionary fiscal policy, once adopted, is built into the structure of the economy.
D) automatic stabilizers, once adopted, are built into the structure of the economy.

Question 71

According to the Keynesian view, if policy makers thought the economy was about to enter an inflationary boom, which of the following would be most appropriate?

A) a tax increase
B) a planned increase in the budget deficit
C) an increase government expenditures
D) a tax decrease

Question 72

Discretionary fiscal policy involves

A) expansion of government revenues during a period of rapid growth.
B) contraction of government revenues during a recession.
C) automatic adjustments that affect the size of the budget deficit or surplus.
D) an intentional change in taxation or government spending.
E) both a and b.

Question 73

If policy makers believe that an inflationary boom is about to begin, the Keynesian view indicates that they should

A) increase the budget deficit.
B) increase government spending and hold taxes constant.
C) decrease government spending and/or raise taxes.
D) hold government spending constant and decrease taxes.

Question 74

When an economy expands into an economic boom, automatic stabilizers will tend to

A) enlarge the budget deficit (or reduce the surplus).
B) reduce the budget deficit (or increase the surplus).
C) ensure that the budget will remain in balance.
D) reduce the supply of money and, thereby, retard aggregate demand.

Question 75

According to the Keynesian model, which of the following policies would be most appropriate during a period of rapid inflation?

A) a tax cut
B) a budget deficit
C) a budget surplus
D) an increase in the money supply

Question 76

When an economy dips into recession, automatic stabilizers will tend to

A) enlarge the budget deficit (or reduce the surplus).
B) reduce the budget deficit (or increase the surplus).
C) ensure that the budget remains in balance.
D) expand the supply of money and, thereby, stimulate aggregate demand.

Question 77

The major advantage of automatic stabilizers is that they

A) guarantee the federal budget will be balanced in a relatively short amount of time.
B) institute countercyclical fiscal policy without the delays associated with legislative action.
C) automatically produce surpluses during recessions and deficits during expansions.
D) require discretionary actions on the part of Congress before they exert an impact on output and employment.

Question 78

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

A) Congress legislates lower tax rates to increase consumption and investment.
B) Tax rates are increased during a recession to maintain a balanced budget.
C) A regressive income tax system reduces tax revenues (as a share of income) as income expands.
D) Revenues from the corporate income tax increase sharply during a business boom but decline substantially during a recession, even though no new tax legislation has been enacted.

Question 79

Which of the following best illustrates the use of discretionary countercyclical fiscal policy?

A) Congress provides $90 billion in relief aid for hurricane victims.
B) Congress appropriates $50 billion to help the needy, and the appropriation is financed by a tax on wealth.
C) Income tax receipts are smaller because of a decline in real GDP during a recession.
D) Congress passes a bill authorizing $100 billion in additional spending when it receives news of a deepening recession.

Question 80

The optimal time for the implementation of restrictive fiscal policy would be

A) before inflation accelerated.
B) after inflation accelerated.
C) during a recession.
D) after the price level had risen significantly.