138 ❯ Step 4. Review the Knowledge You Need to Score High
❯ Answers and Explanations
- The crowding-out effect from government bor-
rowing is best described as
(A) the rightward shift in AD in response to the
decreasing interest rates from contractionary
fiscal policy.
(B) the leftward shift in AD in response to the
rising interest rates from expansionary fiscal
policy.
(C) the effect of the President increasing the
money supply, which decreases real interest
rates, and increases AD.
(D) the effect on the economy of hearing the
chairperson of the central bank say that he or
she believes that the economy is in a recession.
(E) the lower exports due to an appreciating
dollar versus other currencies. - Which of the following fiscal policies is likely to
be most effective when the economy is experienc-
ing an inflationary gap?
(A) The government decreases taxes and keeps
spending unchanged.
(B) The government increases spending and
keeps taxes unchanged.
(C) The government increases spending matched
with an increase in taxes.
(D) The government decreases spending and
keeps taxes unchanged.
(E) The government increases taxes and decreases
spending.
5. Which of the following would likely slow a
nation’s economic growth?
(A) Guaranteed low-interest loans for college
students
(B) Removal of a tax on income earned on saving
(C) Removal of the investment tax credit
(D) More research grants given to medical
schools
(E) Conservation policies to manage the renew-
able harvest of timber
6. The U.S. economy currently suffers a recessionary
gap, and a budget deficit exists. If the government
wishes to fix the recession, which of the following
choices best describes the appropriate fiscal policy,
the impact on the market for loanable funds, the
interest rate, and the market for the U.S. dollar?
FISCAL LOANABLE INTEREST MARKET
POLICY FUNDS RATE FOR $
(A) Tax Demand Falling Demand
increase rises falls
(B) Tax Supply Rising Demand
cut rises rises
(C) Tax Demand Rising Demand
cut rises rises
(D) Tax Supply Falling Demand
increase falls rises
(E) Tax Supply Rising Demand
cut falls falls- D—This is expansionary policy, and the others
either contract the economy or do nothing. - A—In an expansion, households should earn
more income, which increases the taxes paid to
the government. At the same time, people who
needed welfare, or other government assistance,
do not need it now because the unemployment
level is low and wages are high. In this time of
prosperity, the government should run a budget
surplus.
3. B—If the government borrows to expand the
economy, interest rates rise, thus crowding out
private investors. This shifts AD leftward, weak-
ening the fiscal policy impact.
4. E—Real GDP is at a level above full employ-
ment, so AD must be shifted leftward. Choice
D shifts AD to the left and lessens the inflation-
ary gap, but choice E couples higher taxes with
lower spending and therefore is the most effec-
tive remedy. All other choices increase AD and
worsen the inflationary gap.