1.An increase in government spending will have a larger effect on real GDP if A.
ID: 2439102 • Letter: 1
Question
1.An increase in government spending will have a larger effect on real GDP if
A. the marginal propensity to import rises
B. the marginal propensity to consume falls
C. the marginal propensity to save falls
2. If private sector spending is very responsive to changes in interest rates, an increase in government spending will have a larger effect on real GDP.
True
False
3.Given an MPC of 0.7 and assuming no crowding-out effect, for a closed economy an increase of $2B in government spending causes
A. $4.67B worth of spending due to multiplier effects
B. a total change in spending of $2.87B
C. a total of $6.67B in spending plus additional spending due to multiplier effects
D. an increase of $1.4B spending in the first round
4.Which fiscal policy would NOT promote long run economic growth?
A. More generous employment insurance benefits
B. Increased spending on infrastructure
C. Reduced business taxes
D. Grants to university students
5.John Maynard Keynes believed that during times of high unemployment, government should
A. leave the economy alone to self-correct since fiscal policies are actually destabilizing
B. focus on maintaining a balanced budget
C. focus on policies that shift the AD curve to the right
D. focus on policies that shift the SRAS curve to the right
1.An increase in government spending will have a larger effect on real GDP if
A. the marginal propensity to import rises
B. the marginal propensity to consume falls
C. the marginal propensity to save falls
Explanation / Answer
1.
An increase in government purchases would have a larger effect on real GDP if the multiplier effect is large.i.e. when an increase in government spending induces a greater increase in real GDP. Numerically, it is 1/mps or 1/(1-mpc) where mpc is marginal propensity to consume and mps is marginal propensity to save in a closed economy. Hence the multiplier effect would be greater if mpc is larger or mps is smaller
the correct option is (c)
2.
If private spending is very responsive to change in the rate of interest then an increase in government spending leads to higher interest would lower the investment spending and also real GDP would fall by a greater amount as the responsiveness to increase in the rate of interest is large. This is known as crowding out.
the correct option is True
3.
If MPC is 0.7 then for a closed economy, investment multiplier will be 1/(1-mpc)= 10/3 or 3.3. when government purchases increase by $2bn then by the multiplier formula as
multiplier= change in income/ change in government spending
change in income is 3.3.*2 = $6.6bn
the correct option is (c)
4.
A fiscal policy regarding more generous employment insurance benefits cannot promote long-run growth as increasing job security makes the labor inefficient and less competitive in the long run and it should only be used as a short-term remedy and such benefits need not be generous but performance based.
the correct option is (a)
5.
JM Keynes major tool was changed in aggregate demand in order to stabilize the economy so in case of unemployment in the economy one cannot rely on self-correcting mechanism but focus on policies that increase AD to the right.
the correct option is (c)
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