AP_Krugman_Textbook

306 section 6 Inflation, Unemployment, and Stabilization Policies

Tackle the Test: Multiple-Choice Questions

1. If government spending exceeds tax revenues, which of the
   following is necessarily true? There is a
   I. positive budget balance.
   II. budget deficit.
   III. recession.
   a. I only
   b. II only
   c. III only
   d. I and II only
   e. I, II, and III


2. Which of the following fiscal policies is expansionary?
   Taxes Government spending
   a. increase by $100 million increases by $100 million
   b. decrease by $100 million decreases by $100 million
   c. increase by $100 million decreases by $100 million
   d. decrease by $100 million increases by $100 million
   e. both (a) and (d)


3. The cyclically adjusted budget deficit is an estimate of what the
   budget balance would be if real GDP were
   a. greater than potential output.
   b. equal to nominal GDP.

c. equal to potential output.

d. falling.

e. calculated during a recession.

4. During a recession in the United States, what happens
   automatically to tax revenues and government spending?
   Tax revenues Government spending
   a. increase increases
   b. decrease decreases
   c. increase decreases
   d. decrease increases
   e. decrease does not change


5. Which of the following is a reason to be concerned about
   persistent budget deficits?
   a. crowding out
   b. government default
   c. the opportunity cost of future interest payments
   d. higher interest rates leading to decreased long-run growth
   e. all of the above

Tackle the Test: Free-Response Questions

1. Consider the information provided below for the hypothetical
   country of Zeta.
   Tax revenues =2,000
   Government purchases of goods and services =1,500
   Government transfers =1,000
   Real GDP =20,000
   Potential output =18,000
   a. Is the budget balance in Zeta positive or negative? What is
   the amount of the budget balance?
   b. Zeta is currently in what phase of the business cycle?
   Explain.
   c. Is Zeta implementing the appropriate fiscal policy given the
   current state of the economy? Explain.
   d. How does Zeta’s cyclically adjusted budget deficit compare
   with its actual budget deficit? Explain.


2. Explain how each of the following events would affect the
   public debt or implicit liabilities of the U.S. government, other
   things equal. Would the public debt or implicit liabilities be
   greater or smaller?
   a. The growth rate of real GDP increases.
   b. Retirees live longer.

c. Tax revenue decreases.

d. The government borrows to pay interest on its current

public debt.

4. Suppose the economy is in a slump and the current public debt
   is quite large. Explain the trade - off of short - run versus long - run
   objectives that policy makers face when deciding whether or not
   to engage in deficit spending.

Answer (8 points)

1 point:Negative

1 point:− 500

1 point:Expansion

1 point:Real GDP > potential output

1 point:No

1 point:Zeta is running a budget deficit during an expansion.

1 point:It is larger.

1 point:Because if real GDP equaled potential output, tax revenues would be

lower and government transfers would be higher.

2. In Module 29 you learned about the market for loanable funds,
   which is intimately related to our current topic of budget
   deficits. Use a correctly labeled graph of the market for loanable
   funds to illustrate the effect of a persistent budget deficit.
   Identify and explain the effect persistent budget deficits can
   have on private investment.