306 section 6 Inflation, Unemployment, and Stabilization Policies
Tackle the Test: Multiple-Choice Questions
- 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 - 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) - 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.
- 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 - 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
- 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. - 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.
- 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.
- 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.