18) The federal budget deficit acts as an automatic stabilizer because
A) government tax revenues decrease during a recession.
B) unemployment insurance payments decrease during a recession.
C) food stamp payments increase during expansionary periods.
D) Medicaid payments increase during expansionary periods.
19) During recessions, government expenditure automatically
A) falls because of programs such as unemployment insurance and Medicaid.
B) rises because of programs such as unemployment insurance and Medicaid.
C) falls because of the progressive income tax system.
D) rises because of the progressive income tax system.
20) The cyclically adjusted budget deficit calculates the budget surplus or deficit at
A) real GDP.
B) potential GDP.
C) nominal GDP.
D) average GDP.
21) If the federal budget has an actual budget deficit of $100 billion and a cyclically adjusted budget
deficit of $75 billion, then the economy
A) must be at potential real GDP.
B) must be below potential real GDP.
C) must be above potential real GDP.
D) could be below or above potential real GDP.
22) Suppose that the federal budget is balanced when GDP is at potential GDP. If equilibrium GDP falls
below potential,
A) this will result in a current budget deficit.
B) the cyclically adjusted budget will be balanced.
C) government transfer payments will be rising and tax receipts will be falling.
D) All of the above are correct.
23) During most of the years of the Great Depression, the actual federal budget was in ________, and the
cyclically adjusted budget was in ________.
A) deficit; surplus
B) surplus; surplus
C) deficit; deficit
D) surplus; deficit
24) Suppose the government wants to maintain a balanced budget. To achieve this goal, when the
economy falls into recession government would need to ________ taxes, which would cause aggregate
demand to ________.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
25) The nation of Hyperbole is in a recession, and the government decides to increase taxes and reduce
government spending to reduce the growing deficit. This will ________ aggregate demand and will
likely ________ real GDP and employment.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
26) Some economists argue that the federal government should normally run a deficit at potential GDP,
with the borrowed funds applied to
A) consumption goods.
B) investment goods.
C) social security benefits.
D) health care costs.
27) Borrowing to pay for long-lived capital expenditures makes sense as
A) the benefits are received in the current year so the burden of paying for them should be spread over
many years.
B) the benefits are received over many years so the burden of paying for them should be spread over
many years.
C) the benefits are received in the current year so the burden of paying for them should be paid in the
current year.
D) the benefits are received over many years so the burden of paying for them should be paid in the
current year.
28) The total value of U.S. Treasury bonds outstanding equals
A) the federal government deficit.
B) the federal government surplus.
C) the federal government debt.
D) the cyclically adjusted budget deficit.
29) The federal government debt ________ when the federal government runs a deficit and ________
when the federal government runs a surplus.
A) increases; increases
B) decreases; increases
C) increases; decreases
D) decreases; decreases
30) The federal government debt as a percentage of GDP did not rise
A) during the Great Depression.
B) during World War II.
C) during the 1960s.
D) during the 1980s.
31) Accumulating debt poses a problem for the U.S. federal government because
A) it is currently in danger of defaulting on the debt.
B) a large debt-to-GDP ratio causes crowding out.
C) building roads and bridges do not yield enough benefits to justify their cost.
D) the debt has to ultimately be paid off.
32) The budget deficit increases during wars and recessions.
33) Increasing the federal budget deficit will contribute to increasing the federal government debt.
34) The majority of the federal government debt is held by government agencies.
35) The cyclically adjusted budget is calculated at potential GDP.
36) A law requiring the government to balance its budget in each year would serve as an automatic
destabilizer.
37) If the federal budget has an actual budget surplus of $75 billion, but a cyclically adjusted budget
surplus of $50 billion, then the economy must be above potential real GDP.
38) If the federal budget goes from a budget deficit in Year 1 to a budget surplus in Year 2, does it
follow that the federal government acted to raise taxes or cut government spending in Year 2?
39) In Year 1 suppose the economy is at potential GDP and that the federal budget deficit equals $100
billion. In Year 2 the federal budget deficit rises to $150 billion, but the cyclically adjusted budget deficit
falls to $75 billion. How can the actual budget deficit rise and the cyclically adjusted budget deficit fall?
40) Assume a country is required by law to balance the budget every year. Suppose aggregate demand
falls, causing a recession and a budget deficit. To balance the budget, what would the government need
to do with the level of government spending and taxes? How would these changes in government
spending and taxes affect aggregate demand and the economy?
Article Summary
In a letter to Congress, Treasury Secretary Jacob Lew stated that the United States will run out of
money by November 3 unless the $18.1 trillion debt limit was raised. Many Republicans want to use
the debt limit as a negotiating point with the White House to get concessions on government
spending, and the White House has stated that it will not negotiate with Republicans over the debt
limit. Raising the debt limit allows the government to borrow in order to pay current debts, but does
not approve new spending by the government. Without an agreement about raising the debt limit,
the government could face a shut-down in mid-December, when government funding expires.
Source: Nick Timiraos and Kristina Peterson, “U.S. Could Run Out of Cash After Nov. 3, Treasury
Secretary Lew Says,” Wall Street Journal, October 15, 2015.
41) Refer to the Article Summary. When does the Treasury Department borrow? Why would the
Treasury have to borrow more than it estimated, as was indicated by its letter to Congress to raise the
debt ceiling? When would the Treasury repay what it borrowed, and who is it repaying?
42) How could the existence of an unemployment insurance system or other transfer programs have
reduced the severity of the Great Depression?
43) The federal budget exhibited a $128.7 billion surplus in 2001 but moved to a deficit of $157.8 billion
in 2002. Some argued the deficit was opened up because of the Bush 2001 tax cuts, but others argued
that the deficit grew because of the recession suffered in 2001. Evaluate the validity of the second
argument.
44) The federal budget was in deficit from 1931 to 1939, except in the year 1937. Given this fact, how do
you explain E. Cary Brown’s statement, “Fiscal policy, then, seems to have been an unsuccessful
recovery device in the ‘thirties-not because it did not work, but because it was not tried.”
16.7 The Effects of Fiscal Policy in the Long Run
1) Which of the following best describes supply-side economics?
A) Labor productivity affects aggregate supply.
B) Education affects labor productivity which affects aggregate supply.
C) Education affects the incentive to work, save, and invest and, therefore, aggregate supply.
D) Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest and, therefore,
aggregate supply.
2) The tax wedge is the difference between the
A) amount of taxes needed to balance the federal budget and the actual amount of taxes.
B) amount of taxes needed to pay off the national debt and the actual amount of taxes.
C) pretax and posttax returns to an economic activity.
D) nominal and real interest rates.
3) A decrease in which of the following would decrease the tax wedge?
A) marginal tax rate
B) money supply
C) national debt
D) federal budget deficit
4) Economists who believe the supply-side effects of tax cuts are small essentially believe that
A) tax cuts mainly affect aggregate demand.
B) tax cuts mainly affect aggregate supply.
C) tax cuts will increase the quantity of labor supplied.
D) tax cuts will result in relatively small changes in the price level.
5) Compare the effect on the price level and real GDP of a decrease in tax rates assuming a supply-side
effect versus no supply-side effect. Compared to no supply-side effect, including a supply-side effect
for the decrease in tax rates will cause the price level to increase ________ and real GDP to increase
________.
A) less; less
B) less; more
C) more; less
D) more; more
6) Fiscal policy actions that are intended to have long-run effects on real GDP attempt to increase
________ through changing ________.
A) aggregate demand; government spending
B) aggregate supply; taxes
C) aggregate demand; taxes
D) aggregate supply; government spending
7) As the tax wedge associated with a given economic activity gets smaller, we would expect
A) more of that economic activity to occur.
B) the distortions caused by taxes on that activity to be greater.
C) people to engage in less of that particular activity.
D) no change in the practice of that activity until the tax wedge ultimately disappears.
8) Reducing the marginal tax rate on income will
A) reduce the tax wedge faced by workers and increase labor supplied.
B) raise the return to entrepreneurship and encourage the opening of new businesses.
C) increase the after-tax return on saving, and encourage saving.
D) All of the above are correct.
9) Double taxation refers to
A) corporations paying taxes on profits and individuals paying taxes on wage income.
B) individuals paying taxes on wage income and individuals paying taxes on dividends.
C) corporations paying taxes on profits and individuals paying taxes on dividends.
D) corporations paying taxes on capital gains and individuals paying taxes on wage income.
10) If tax reduction and simplification are effective, then
A) real wages will rise as labor supply and demand increase.
B) saving and investment in new capital will increase.
C) interest rates will rise in financial markets and demand for financial assets falls.
D) fewer new firms will be established, since existing firms will make more profit.
11) Tax reduction and simplification should ________ long-run aggregate supply and ________
aggregate demand.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease