Question

If the economy is close to full employment, an increase in government spending may increase GDP in the short run, but in the long run, this policy may: reduce investment in new capital. make domestic businesses less competitive in international markets if the dollar appreciates in value raise interest rates and reduce consumer expenditures on cars and new houses All of these options are correct Which of the following is considered contractionary fiscal policy? The government increases defense spending due to a change in priorities. The government increases the income tax rate. The government reduces family benefit for high-income families to reduce inequality. A state (not federal) government cuts highway spending to balance its budget.

Answer 1

1. Fiscal policy is the policy related to revenue, expenditure and debt of the government for achieving a set of definite objectives. The object of fiscal policy before the fullemployment is to increase GDP and price stability has a little concern to the government. But after or at the fullemployment the object of fiscal policy changes from growth to price control.

If the economy in near to fullemployment the increased government spending increase GDP in shortrun but it has adverse effect in longrun. The government adopts public borrowing to mobilize resource for increased spending. This increased borrowing rise the rate of interest which in turn reduce the private investment in new capital assets in longrun.

The increased rate of interest in the domestic market causes the flow of foreign capital into the country. Then the value of currency appreciates. Thus domestic goods become less attractive in foreign market. In other words the domestic business in foreign market becomes less competitive in the international market due to increased price.

The increased rate of interest due to increased borrowing by the government reduces the demand for consumer goods and services. The increased price level in the domestic market reduces the real purchasing power of money. Thus the consumers demand less. On the other hand the consumers are often resort to borrowed money to meet their consumption demand. The increased cost of borrowed fund compels them to reduce their consumption demand.

Answer: All of these options are correct.

2. The contractionary and expansionary fiscal policies are adopted depending on the prevailing economic condition of the economy. During times of inflation the government adopts a contractionary fiscal policy (increase the tax rate, reduction in public expenditure and incurring additional borrowing). But during times of deflation the government adopts an expansionary fiscal policy of reduced tax, increased public expenditure and the repayment of old borrowing.

Answer: The government increases the income tax rate.

Answer 2

SOLUTION :

First question :

4th option : All of these are correct . (ANSWER)

[ Increasing beyond full employment will create inflationary trend and rise in wages due to short labour supply. So, in the long run, investment in new capital will decrease.

Prices will rise in the domestic market and so it will make country less competitive in the international market.

Inflation will force the central bank to raise interest rates to control consumer expenditures particularly on high valued items such as cars and houses. ]

Second question :

2nd option : The government increases the income tax rates .

{ increasing income tax rate will reduce spendable income and control consumer expenditures. This will contract the economy. Hence, it is contractional fiscal policy. ]