Question

1. To stimulate economic activity during a severe recession, the strongest appropriate fiscal policy is: a. an increase in taxes and/or an increase in government spending b. an increase in taxes and/or a decrease in government spending! c. a decrease in taxes and/or an increase in government spending d. a decrease in taxes and/or a decrease in government spending e. a decrease in government purchases and/or a decrease in transfer payments 2. An increase in income tax rates: a. makes the aggregate expenditures function steeper, and lowers the size of the multiplier b. makes the aggregate expenditures function steeper, and raises the size of the multiplier c. makes the aggregate expenditures function flatter, and lowers the size of the multiplier d. makes the aggregate expenditures function flatter, and raises the size of the multiplier e. lowers aggregate expenditures, but has no effect on the size of the multiplier 3. An illustration of the term "automatic stabilizer" is provided by: a. the tendency of tax collections to rise as the economy moves into a recession b. the tendency of tax collections to fall as the economy moves into a recession c. increases in tax rates as the economy moves into a recession d. decreases in tax rates as the economy moves into a recession e. public works designed to get the economy out of a depression 4. The full-employment budget will be in: a. surplus, if the economy is below full employment and the actual budget is balanced b. deficit, if the economy is below full employment and the actual budget is balanced c. deficit, whenever the economy is below full employment d. surplus, whenever the economy is below full employment e. we don't have enough information; any one of the above statements may be correct

Answer 1

1. Note that in the case of the recession where there is a lack of demand in the market, the best way to recover the economy is by increasing the government purchases and reduce the taxes to increase the disposable income with the general public. Thus the correct answer is c.

2. An increase in income taxes reduces disposable income with the general public. A decline in the income further reduces the aggregate demand and hence the GDP of the economy. Note that this decline would be a multiple value and not by the exact change which is known as the multiplier. So an increase in taxes decreases the consumption level and hence the aggregate demand (making it steeper). The multiplier value, on the other hand, will decrease and hence the correct answer is a.

3. Automatic stabilizers are the tools which offset the fluctuations in the economic activity without interference by the government and tend to stabilize the economy. here, note that decline in the income would automatically be followed by a decline in the tax rates and hence taxes work as the automatic stabilizers. Thus d is the correct answer.

4. When the economy is below the full employment level, the budget turns out to be in deficit which is because the decline in the national product at the lower employment level would reduce the revenue of the government and thus teh deficit. Hence c is the correct answer.