Economics Chapter 11—Fiscal Policy: The Keynesian View and the Historical
Development of Macroeconomics
MULTIPLE CHOICE
1. Which of the following would a Keynesian economist be most likely to stress?
a.
Supply creates its own demand.
b.
Businesses will not produce goods and services if they do not think people will buy them.
c.
You cannot spend your way out of a recession.
d.
When the unemployment rate is high, wage rates will fall.
e.
A dollar saved is a dollar earned; a high rate of saving is the key to prosperity.
2. When Keynesian equilibrium is present,
a.
aggregate demand for goods and services will equal the current rate of output.
b.
business inventories will be increasing.
c.
full employment must be present.
d.
the actual rate of unemployment must equal the natural rate of unemployment.
3. The Great Depression provided support for Keynes’ view that
a.
government action was necessary to ensure interest rates remained at the equilibrium level.
b.
prolonged periods of unemployment would be present when demand is deficient.
c.
falling resource prices would bring the economy out of a recession.
d.
lower interest rates would quickly restore the full employment equilibrium of an economy.
4. The multiplier principle indicates that if business decision makers become more optimistic about the
future and, as a result, increase their investment expenditures by $82 billion, real GDP
a.
will increase by less than $82 billion if the economy was initially operating well below
capacity.
b.
will increase by more than $82 billion if the economy was initially operating well below
capacity.
c.
will increase by more than $82 billion if the economy was initially operating at
full-employment capacity.
d.
will decline if the marginal propensity to consume is less than 1.
5. Rather than seeking to balance the budget, Keynesian economists argue that the government’s tax and
spending policies should be determined by the
a.
demand for government-provided public goods.
b.
level of aggregate demand required to achieve full employment of resources.
c.
size and quality of the labor force.
d.
need to expand or contract the supply of money.
6. If an economy were experiencing a high rate of unemployment as the result of weak aggregate
demand, a Keynesian economist would be most likely to recommend
a.
a reduction in taxes coupled with a reduction in government expenditures of equal size.
b.
an increase in government expenditures coupled with an increase in taxes of equal size.
c.
a reduction in taxes, without any offsetting reduction in government expenditures.
d.
maintenance of a balanced budget.
7. Which of the following is a problem with discretionary fiscal policy as an economic stabilization tool?
a.
Discretionary changes in fiscal policy can be easily anticipated by private decision makers.
b.
It is difficult to properly time discretionary changes in fiscal policy.
c.
Discretionary fiscal policy is only effective during a recession.
d.
Discretionary fiscal policy is only effective during an economic boom.
8. Within the Keynesian model, if the output of an economy is less than the full-employment level, then
a.
a reduction in government expenditures will direct the economy back to full-employment
equilibrium.
b.
a reduction in wage rates and resource prices will quickly restore full-employment
equilibrium.
c.
a reduction in the real interest rate will soon restore full-employment equilibrium.
d.
output will tend to remain below full-employment capacity unless aggregate expenditures
increase.
9. Which of the following is an important insight of Keynesian analysis?
a.
When an economy is in a recession, lower interest rates and lower wage rates will quickly
direct the economy back to full employment.
b.
When widespread unemployment is present, increases in aggregate demand will exert a
larger impact on real output than when the economy is operating at or near full
employment.
c.
When an economy is in a recession, it makes sense to increase taxes and reduce
government expenditures.
d.
A balanced budget is the key to maintenance of full employment.
10. A major advantage of built-in or automatic stabilizers is that they
a.
guarantee the federal budget will be balanced over the course of the business cycle.
b.
require no Congressional action to be effective.
c.
automatically produce surpluses during recessions and deficits during inflation.
d.
require discretionary actions on the part of Congress before they exert an impact on output
and employment.
11. The 1930s were a period of
a.
strong economic expansion and rapid growth of real output.
b.
high rates of inflation coupled with a low rate of unemployment.
c.
depressed economic conditions and prolonged high rates of unemployment.
d.
strong growth of real output even though the general level of prices was declining.
12. The Keynesian model provided an explanation for
a.
the prolonged unemployment of the 1930s.
b.
the double-digit inflation rates of the 1970s.
c.
the high unemployment rates of the 1970s.
d.
the high inflation rates of the 1930s.
13. Keynesian economists believed that the prolonged unemployment of the 1930s was the result of
a.
the sharp reduction in the supply of money during 1929-1933 and another monetary
contraction in 1938.
b.
the high interest rates of the 1930s.
c.
the double-digit inflation of the 1930s.
d.
insufficient aggregate demand and the failure of market forces to direct the economy
back to full employment.
14. Prior to the time of John Maynard Keynes, most economists stressed that
a.
low levels of aggregate demand would lead to prolonged periods of unemployment.
b.
market economies were inherently unstable because of fluctuating aggregate demand.
c.
market adjustments would automatically direct an economy to full employment within a
relatively brief period of time.
d.
budget deficits and surpluses were necessary for the control of economic fluctuations.
15. Prior to the Great Depression, most economists believed that a recessionary downturn would be
reversed by
a.
higher wages that would stimulate aggregate demand and reduce unemployment.
b.
lower wages that would increase the quantity of labor demanded and reduce
unemployment.
c.
an expansionary monetary policy on the part of the Federal Reserve System.
d.
an increase in government spending that would stimulate aggregate demand and
employment.
16. Keynes rejected the view that lower wages would direct a recessionary economy back to full
employment because
a.
lower wages would cause the central bank to reduce the money supply and thereby prolong
the recession.
b.
lower wages would stimulate inflation and thereby prolong the recession.
c.
market forces would quickly direct an economy back to full employment.
d.
powerful trade unions and large corporations made wages highly inflexible.
17. In the Keynesian view, equilibrium takes place when
a.
the real and nominal interest rates are equal.
b.
the level of total spending in the economy is equal to current output.
c.
current output is equal to the economy’s long-run potential.
d.
the money supply is growing at a constant rate.
18. According to the Keynesian view, the prolonged unemployment of the Great Depression
a.
was surprising because Keynesians believed that wage rates would decline and direct the
economy to full employment.
b.
was surprising because Keynesians believed that lower interest rates would direct the
economy to full employment.
c.
resulted because the total expenditures on goods and services were less than the
full-employment rate of output.
d.
resulted because the federal government ran large budget deficits during the 1930s.
19. Within the framework of the Keynesian model,
a.
changes in output rather than changes in prices direct the economy to equilibrium.
b.
changes in prices rather than changes in output direct the economy to equilibrium.
c.
changes in interest rates and resource prices will direct the economy to equilibrium.
d.
the economy will continually be in equilibrium.
20. Within the framework of the Keynesian model, if spending is abnormally low,
a.
the economy will be in equilibrium at full employment, but inflation will be high.
b.
equilibrium output will be less than the full-employment rate of output.
c.
the equilibrium output rate will exceed the economy’s full-employment capacity.
d.
the actual rate of unemployment will be less than the natural rate of unemployment.
21. Keynesian analysis indicates that an unexpected decline in aggregate demand will lead to
a.
a reduction in inventories and an expansion in employment.
b.
an increase in inventories and a reduction in output.
c.
lower interest rates, which will stimulate aggregate demand and keep the economy at full
employment.
d.
a lower price level, which will quickly guide the economy to full-employment equilibrium.
22. Within the Keynesian model, when total spending is less than the full-employment level of output,
firms will
a.
continue to produce the current level of output.
b.
cut production to reduce their inventory accumulation.
c.
expand production to reduce their inventory accumulation.
d.
cut production to build inventories.
23. According to the Keynesian view, if purchasers buy more goods and services than businesses expect,
a.
the inventories of firms would decline, and the firms would expand output in order to
restore their inventories to desired levels.
b.
the inventories of firms would increase, and the firms would reduce output until
inventories were cut back to the desired level.
c.
the current level of income would persist in the future.
d.
firms would reduce their investment, and the economy would fall into a recession.
24. When aggregate demand exceeds current output, Keynesian analysis indicates that
a.
unplanned inventory accumulation will cause output to rise.
b.
unplanned inventory accumulation will cause output to fall.
c.
unplanned inventory reductions will cause output to rise.
d.
unplanned inventory reductions will cause output to fall.
25. As the marginal propensity to consume (MPC) decreases, the spending multiplier
a.
increases.
b.
decreases.
c.
remains constant.
d.
becomes indefinable.
26. As the marginal propensity to consume (MPC) increases, the spending multiplier
a.
increases.
b.
decreases.
c.
remains constant.
d.
becomes indefinable.
27. The expenditure multiplier indicates that
a.
changes in investment, government, or consumption spending can trigger much larger
changes in output.
b.
an increase in saving will cause output to rise by a multiple of the additional saving.
c.
a market economy will be more stable than classical economists thought.
d.
the marginal propensity to consume is greater than one.
28. The multiplier effect refers to the fact that a change in spending (aggregate demand) will
a.
increase the money supply.
b.
cause prices to rise by some multiple of the initial increase in spending.
c.
cause nominal output to rise by some multiple of the initial increase in spending.
d.
reduce prices by some multiple of the increase in spending.
29. Mathematically, the marginal propensity to consume is
a.
consumption divided by income.
b.
the change in consumption divided by the change in income.
c.
income divided by consumption.
d.
the change in income divided by the change in consumption.
30. The marginal propensity to consume is defined as the
a.
fraction of total income not spent on consumption.
b.
proportion of any change in income that is spent on consumption.
c.
fraction of total income spent on consumption.
d.
fraction of a change in income that is saved.
31. When an economy is operating well below its full-employment capacity and the marginal propensity
to consume is 3/4, a $10 billion increase in investment will cause the equilibrium income to rise by
a.
$5 billion.
b.
$10 billion.
c.
$20 billion.
d.
$40 billion.
32. The larger the marginal propensity to consume,
a.
the larger the multiplier.
b.
the larger the marginal propensity to save.
c.
the higher the income level of the economy.
d.
the smaller the change in income derived from a given change in government spending.
33. Within the Keynesian model, if the marginal propensity to consume is 0.8, which of the following is
true?
a.
When consumption increases by $5, income increases by $1.
b.
When consumption increases by $1, saving increases by $5.
c.
When investment increases by $1, income increases by $5.
d.
When investment increases by $1, saving increases by $5.
34. The multiplier principle is important because it
a.
was central to economic theory before Keynes.
b.
implies that investment will help stabilize the economy.
c.
shows why small shifts in investment have a powerful influence on national income.
d.
illustrates why a small change in income causes a large change in saving.
35. Within the Keynesian model, the multiplier effect tends to
a.
smooth out the up- and down- swings of the business cycle.
b.
promote price stability.
c.
magnify small changes in spending into much larger changes in output and employment.
d.
reduce the impact of an increase in investment on output and employment.
36. When the unemployment rate is low, the impact of additional spending on real output will
a.
be larger than when the unemployment rate is high.
b.
be smaller than when the unemployment rate is high.
c.
be the same as when the unemployment rate is high.
d.
place downward pressure on the general level of prices, leading to deflation.
37. When there are few unemployed resources, additional spending will tend to
a.
flow directly to the unemployed resources, so that the multiplier can be maintained at
1/1-mpc.
b.
increase the marginal propensity to consume, and thereby increase the size of the
multiplier.
c.
increase the demand for resources and drive prices downward, increasing the size of the
multiplier.
d.
bid resources away from other activities and drive prices upward, reducing the size of the
multiplier.
38. During normal times, if the marginal propensity to consumer is 3/4, and the government borrows $10
billion in order to increase spending by that amount, real output will expand by
a.
more than $40 billion, because both the additional borrowing and the additional spending
will stimulate real output.
b.
$40 billion, because the net multiplier will be 4.
c.
less than $40 billion, because the additional borrowing will place upward pressure on real
interest rates, weakening the impact of the multiplier.
d.
$10 billion, because during normal times, the government can borrow funds without any
increase in interest rates.
39. During normal times, the multiplier effect of an increase in government spending financed by taxes
will be
a.
strengthened, if the additional spending flows into sectors of the economy where the
unemployment rates are low.
b.
weakened by an offsetting reduction in spending due to the higher taxes.
c.
unaffected, as long as the higher taxes are in the future.
d.
strengthened, if corporate tax rates are increased and personal tax rates remain unchanged.
40. If the government increases its spending, which of the following would tend to reduce the size of the
multiplier?
a.
higher taxes for the finance of the additional spending
b.
higher interest rates as the result of additional borrowing to finance the spending
c.
the flow of the spending into sectors where the unemployment rate is low
d.
all of the above
41. The primary tool of fiscal policy is
a.
the money supply.
b.
the stock market.
c.
the federal budget.
d.
regulation of the bond market.
42. A balanced budget is present when
a.
the economy is at full employment.
b.
the actual level of aggregate spending equals the planned level of spending.
c.
public sector spending equals private sector spending.
d.
government revenues equal government expenditures.
43. When the federal government is running a budget deficit,
a.
government revenues exceed government expenditures.
b.
government expenditures exceed government revenues.
c.
the economy must be in an economic recession.
d.
the size of the national debt will decline.
44. If the federal government is running a budget surplus,
a.
its expenditures must be greater than its revenues.
b.
the supply of money will decline.
c.
it will be able to reduce its outstanding debt.
d.
the U.S. Treasury will have to borrow additional funds in order to cover the surplus.
45. Which of the following provides the best information about the direction of the government’s fiscal
policy?
a.
changes in the Fed’s holdings of U.S. government securities
b.
changes in the reserve requirements of the Federal Reserve
c.
changes in the nation’s trade balance
d.
changes in the size of the federal government’s budget deficit or surplus
46. If the government owes $15.0 trillion and then borrows $900 billion more this year, this leads to
a.
a debt of $900 billion and a deficit of $15.9 trillion.
b.
a debt of $15.9 trillion and a deficit of $900 billion.
c.
a debt of $14.1 trillion and a deficit of $900 billion.
d.
a debt of $15.0 trillion and a deficit of $14.1 trillion.
e.
a debt of $15.9 trillion and a deficit of zero.
47. Federal budget deficits generally grow during recessions because
a.
both tax revenues and transfer payments decrease.
b.
both tax revenues and transfer payments increase.
c.
tax revenues decrease while transfer payments increase.
d.
tax revenues increase while transfer payments decrease.
e.
tax revenues decrease but transfer payments are unchanged.
48. Which of the following would decrease the size of a federal budget deficit?
a.
a recession
b.
an increase in defense spending
c.
growth in real GDP
d.
a decrease in tax revenues
e.
an increase in transfer payments
49. Changes in government spending and/or taxes as the result of legislation, is called
a.
open market operations of the Federal Reserve.
b.
discretionary fiscal policy.
c.
balanced budget operations.
d.
discretionary monetary policy.
50. Why does a tax change affect aggregate demand?
a.
A tax change alters saving by an equal amount.
b.
A tax change alters imports and net exports.
c.
A tax change alters government spending by an equal amount.
d.
A tax change alters disposable income and consumption spending.
51. The government is pursuing an expansionary fiscal policy if it
a.
decreases government spending and increases taxes.
b.
increases government spending or increases taxes.
c.
decreases government spending or reduces taxes.
d.
increases government spending and/or reduces taxes.
52. Fiscal policy designed to increase aggregate demand during economic downturns and decrease
aggregate demand during economic booms is called
a.
business cycle fiscal policy.
b.
new classical fiscal policy.
c.
supply-side fiscal policy.
d.
countercyclical fiscal policy.
53. Which of the following best expresses the central idea of countercyclical fiscal policy?
a.
Planned deficits are experienced during economic booms and planned surpluses during
economic recessions.
b.
The balanced-budget approach is the proper criterion for determining annual budget
policy.
c.
Actual deficits should equal actual surpluses during a period of deflation.
d.
Deficits are planned during economic recessions, and surpluses are utilized to restrain
inflationary booms.
54. If Congress votes to increase government purchases and at the same time decrease personal income
taxes, they
a.
have decided to balance the federal budget.
b.
have voted for the proper policy to counteract a recession.
c.
have voted for the proper policy to counteract inflation and an economic boom.
d.
are trying to achieve a federal budget surplus.
55. If the economy is experiencing inflationary boom, and the government lowers taxes in an effort to
balance the budget, the Keynesian model indicates the likely effect will be to
a.
counteract inflation.
b.
reduce the trade deficit.
c.
continue inflationary pressures.
d.
increase unemployment.
56. If the economy is experiencing less than full-employment, the Keynesian model recommends that the
government
a.
do nothing to stimulate the economy.
b.
undertake expansionary fiscal policy to stimulate aggregate demand.
c.
undertake expansionary fiscal policy to stimulate aggregate supply.
d.
balance the budget to stimulate aggregate demand.
57. The Keynesian analysis of fiscal policy implies that
a.
fiscal policy should generally be expansionary except during periods of economic
recession.
b.
fiscal policy should generally be restrictive except during inflationary booms.
c.
the federal budget should be balanced annually except during war.
d.
the federal budget should be used to maintain aggregate demand at a level consistent with
full employment.
58. The prevailing budget philosophy prior to Keynes called for a balanced budget. Keynes argued that the
government should not balance its budget but instead have budget deficits during
a.
economic booms.
b.
during periods of peace but surpluses during periods of war.
c.
periods of inflation.
d.
economic recessions.
59. When an economy is operating below its potential capacity, Keynesian economists argue that
a.
taxes should be raised if the government is currently running a budget deficit.
b.
taxes should be lowered but only if the government is running a budget surplus.
c.
the government should cut taxes and/or increase expenditures in order to stimulate
aggregate demand.
d.
both a and b are correct.
e.
all of the above are correct.
60. According to the Keynesian view, if real GDP is slowing and the economy appears to be headed for a
recession, a reduction in tax rates is
a.
highly appropriate because it will stimulate aggregate demand and, thereby, help to
strengthen the economy.
b.
highly inappropriate because it will either reduce the size of the budget surplus or increase
the size of the deficit.
c.
not very important because the “demand stimulus effects” of the tax cut will be largely
offset by additional borrowing.
d.
not very important because the “demand stimulus effects” of lower current taxes will be
largely offset by the expectation of higher taxes in the future.
61. According to the Keynesian view, if policy makers thought the economy was about to fall into a
recession, which of the following would be most appropriate?
a.
a change in government spending and taxation that will lead to a budget surplus
b.
a planned increase in the budget deficit
c.
reducing government expenditures
d.
balancing the budget
62. Within the framework of the Keynesian model, which of the following would most likely occur if the
federal government increased its spending and enlarged the size of the budget deficit during a period
of full employment?
a.
The rate of inflation would decline.
b.
The rate of inflation would rise.
c.
A recession would develop.
d.
Interest rates would fall.