1) Which of the following is true? a) The government expenditures multiplier inc
ID: 1152775 • Letter: 1
Question
1) Which of the following is true?
a) The government expenditures multiplier increases as “c” increases.
b) Fiscal policy is successful only in recessions.
c) Fiscal policy fixes the economy quite rapidly because tax and spending policies affect aggregate demand instantly.
d) Consumer spending does not immediately react to income tax cuts.
e) Both a and d.
1.1) Which of the following is true?
a) A recessionary gap can be closed completely because of sticky wages.
b) Theoretically, an inflationary gap can eventually lead to stagflation.
c) Wages increase in the time of recession for reasons such as minimum wages, union contacts, and government restrictions.
d) a and b.
2) Which is more likely to happen as a result of a sudden reduction in aggregate demand?
a) Recession only.
b) Inflation only.
c) Stagflation.
d) None.
3) Which of the following is true?
a) In our simple model of aggregate demand the government expenditures multiplier is smaller than the tax multiplier.
b) The tax multiplier is negative suggesting that a reduction in taxes decreases our equilibrium output.
c) The tax multiplier is positive but smaller than the government expenditures multiplier.
d) None of the above.
4) Let c=0.8. Then
a) A 10 dollar increase in disposable income will increase consumption by 2 dollars.
b) A 10 dollar increase in disposable income will decrease consumption by 8 dollars.
c) A 10 dollar increase in disposable income will increase consumption by 8 dollars.
d) A 10 dollar decrease in disposable income will decrease consumption by 8 dollars.
e) c and d.
Explanation / Answer
(1) (e)
Spending multiplier = 1 / (1 - c), therefore as c rises, (1 - c) falls and Multiplier rises.
Also, fiscal policies have inherent time lags which makes consumption impossible to immediately respond to a tax cut.
(1.1) (d)
A recessionary gap can be closed by increasing aggregate demand, and aggregate supply doesn't change in short run due to sticky wages. Also, if aggregate supply keeps falling due to higher price level caused by inflationary gap, if output falls too much or falls below potential GDP level (in absence of any government intervention), there can be a stagflation caused by low output and high inflation.
(2) (a)
Sudden fall in aggregate demand lowers both price level and real GDP, causing recession.
(3) (d)
Government spending multiplier > Tax multiplier.
A negative tax multiplier means, a fall in tax leads to an increase in real GDP and output.
Tax multiplier = [-MPC / (1 - MPC)] < 0
(4) (e)
When c = 0.8, a $N increase (decrease) in disposable income will increase (decrease) consumption by ($0.8 x N). Therefore, a $10 increase (decrease) in disposable income will increase (decrease) consumption by ($0.8 x 10) = $8.
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