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10) If the economy produces a level of output that is too small for equilibrium,
A) there will be an unintended, or unplanned, increase in inventories.
B) businesses will not be able to sell everything that they've produced.
C) there will be an unintended, or unplanned, decrease in inventories.
D) there will be a tendency for output to fall (decline) in the next period.
11) Let's assume that the economy is in a recession, operating $100 billion below the full
employment output. If the marginal propensity to consume is 0.8, in what direction and by what
amount should the level of government spending be changed?
A) decrease government spending by $100 billion
B) increase government spending by $100 billion
C) decrease government spending by $20 billion
D) increase government spending by $20 billion
E) increase government spending by $80 billion
12) Select the best evaluation of the following statement: Increasing government spending by
$10 billion will have a greater impact on the level of equilibrium output than decreasing taxes by
the same amount ($10 billion).
A) False; both changes will have the same impact on GDP.
B) False; a $10 billion decrease in taxes will have a greater impact than a $10 billion increase in
spending.
C) True; since only part of the tax reduction will be spent, the remainder will be saved and will
not stimulate the economy.
D) True; a tax reduction will always create twice as much stimulus as a spending increase of
equal size.
13) If the marginal propensity to consume is 0.75, a $20 billion increase in personal income taxes
will initially reduce consumption spending by
A) $20 billion.
B) $80 billion.
C) $15 billion.
D) $40 billion.
14) The ultimate impact of a $20 billion increase in personal taxes would be to
A) reduce the equilibrium GDP by $20 billion.
B) reduce the equilibrium GDP by $80 billion.
C) reduce the equilibrium GDP by $60 billion.
D) increase the equilibrium GDP by $20 billion.
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1) According to the Keynesian model, if the economy were experiencing unemployment, which
of the following would be most appropriate?
A) an increase in government spending with no change in the level of taxation
B) a reduction in government spending coupled with a tax increase
C) a balanced federal budget
D) a tax increase coupled with an increase in government spending of the same amount
E) an increase in taxes
2) If the economy were experiencing high unemployment, which of the following would a
Keynesian favor?
A) an increase in taxes to help pay the increased claims for unemployment compensation
B) an increase in government spending for interstate highways
C) a reduction in federal spending for space exploration
D) an increase in corporate income taxes
E) a reduction in welfare payments in order to reduce voluntary unemployment
3) When an economic expansion has resulted in substantial inflationary pressures, the proper
Keynesian fiscal policy would be to
A) reduce taxes.
B) increase the size of the government's budget deficit.
C) increase spending by the federal government.
D) reduce the size of the government's budget deficit.
E) reduce taxes but increase government spending.
4) If a recessionary gap exists, which of the following policies would a Keynesian support?
A) an increase in personal income tax rates
B) an increase in interest rates
C) a reduction in the level of government spending
D) an increase in government spending
E) an increase in corporate income tax rates
5) If an inflationary gap existed, increasing government spending would
A) eliminate the gap.
B) make the problem worse.
C) either reduce or eliminate the gap.
D) increase the size of the multiplier.
E) decrease the size of the multiplier.
6) If rapid economic growth resulted in substantial inflation, which of the following policies
would be appropriate, according to the Keynesian model?
A) an increase in government spending
B) a reduction in the tax rates on corporate income
C) an increase in personal income taxes
D) a program of more aggressive antitrust enforcement against firms with substantial market
power
E) policies designed to increase the size of the economy's multiplier
7) If there is a recessionary gap of $100 billion and the economy's MPC is 0.80, which of the
following policies would close the gap without generating inflationary pressures?
A) an increase in government spending of $100 billion
B) an increase in government spending of $500 billion
C) an increase in government spending of $50 billion
D) an increase in government spending of $20 billion
E) a reduction in government spending of $20 billion
8) Other things constant, if the federal government were to reduce personal income taxes,
A) equilibrium output would tend to fall.
B) the consumption function would shift downward.
C) the total expenditure function would shift upward.
D) consumption by households would tend to fall.
E) investment spending by businesses would probably fall.
9) In the Keynesian model, if the marginal propensity to consume is 0.80, a reduction in
government spending of $50 billion would cause the level of equilibrium output and income to
decline by
A) $40 billion.
B) $50 billion.
C) $100 billion.
D) $250 billion.
E) $25 billion.
Page 16
10) In the Keynesian model, if the MPS is 0.25, a $100 billion reduction in taxes would raise the
equilibrium GDP by
A) $25 billion.
B) $75 billion.
C) $200 billion.
D) $300 billion.
E) $400 billion.
11) With an MPC of 0.80, a reduction in taxes of $10 billion would initially cause
A) a reduction in consumption spending of $10 billion.
B) an increase in consumption spending of $50 billion.
C) an increase in consumption spending of $8 billion.
D) an increase in consumption spending of $10 billion.
E) an increase in consumption spending of $18 billion.
12) With an MPC of 0.75, an increase in taxes of $20 billion would initially cause a
A) $20 billion increase in consumption spending.
B) $80 billion increase in consumption spending.
C) $15 billion reduction in consumption spending.
D) $5 billion reduction in consumption spending.
E) $20 billion reduction in consumption spending.
13) Assume the economy has an MPC of 0.8. An increase in taxes of $20 billion would lower the
equilibrium level of GDP by
A) $16 billion.
B) $20 billion.
C) $80 billion.
D) $100 billion.
E) $25 billion.
14) Assume the economy is operating at a level of equilibrium output $200 billion less than full
employment. If the economy's MPC is 0.75, by how much must government spending be
increased to achieve full employment without generating inflation?
A) $200 billion
B) $150 billion
C) $800 billion
D) $50 billion
E) $266.7 billion
15) Assume the economy is operating at a level of equilibrium output $100 billion less than full
employment. If the economy's MPC is 0.80, how much must taxes be reduced to achieve full
employment without generating inflation?
A) $100 billion
B) $50 billion
C) $25 billion
D) $20 billion
E) $80 billion
16) Suppose that MPC is 0.75 and that the full employment output is $760 billion. If the
economy is presently in equilibrium at an output of $1,000 billion, which of the following
policies would a Keynesian recommend?
A) an increase in government spending of $60 billion
B) a reduction in government spending of $240 billion
C) a tax increase of $80 billion
D) a reduction in government spending of $80 billion
E) a tax increase of $60 billion
17) Suppose that MPC is 0.60 and that the full employment output is $500 billion. If the
economy is presently in equilibrium at an output of $450 billion, which of the following policies
would a Keynesian recommend?
A) an increase in government spending of $50 billion
B) a reduction in taxes of $25 billion
C) an increase in government spending of $20 billion
D) an increase in government spending of $25 billion
E) a reduction in taxes of $40 billion
18) An increase in government spending will have a greater impact on equilibrium output than a
tax reduction of the same size because
A) government spends its money more efficiently than private households.
B) part of the tax reduction will be saved.
C) "crowding out" reduces the stimulus of the tax reduction but does not apply to government
spending.
D) increases in government spending are subject to a multiplier effect, but tax reductions are not.
E) government spending tends to stimulate investment spending by businesses, whereas
consumption spending by households has no impact on investment.
1) An increase in the level of equilibrium income in an economy will tend to shift the economy's
consumption function upward.
Page 18
2) Disposable income is income after taxes have been deducted.
3) If Joan earns $30,000 a year and spends $15,000, we know that her marginal propensity to
consume is 0.50 or 50 percent.
4) If an economy's aggregate income increases from $500 billion to $600 billion, and
consumption spending increases from $300 billion to $375 billion, the economy's marginal
propensity to consume is 0.75.
5) If interest rates rise, an economy's consumption function will tend to shift upward.
6) If consumers expect higher prices in the future, the economy's production function will tend to
shift downward.
7) The term investment spending refers to the purchase of stocks and bonds.
8) The term equilibrium output means that the economy is operating at full employment.
9) If producers are experiencing unintended reductions in inventories, the existing level of output
must be too small for equilibrium.
10) Unintended reductions in inventories signal producers to expand production, pushing the
economy toward equilibrium.
11) If an economy experiences a sudden decline in the stock market so that the value of the
stocks held by households falls dramatically, the economy's consumption function would
probably shift upward.
12) Increases or decreases in the level of aggregate income tend to move an economy along a
stationary consumption function, while changes in the level of wealth or the cost of credit tend to
shift the function up or down.
13) Lower interest rates mean less investment spending, ceteris paribus.
14) The level of investment spending tends to be more stable, less changeable, than the level of
consumption spending.
15) If the economy is operating at its equilibrium output, there should be no intended increases
or decreases in inventories.
16) The marginal propensity to consume is 0.75. the economy's marginal propensity to save must
be 4.
17) If the marginal propensity to save is 0.25, the multiplier in the economy is 4.
18) If the marginal propensity to consume is 0.60, a $50 billion increase in investment spending
will increase the economy's equilibrium GDP by $30 billion.
19) If the economy's MPC is 0.80, a $20 billion increase in the level of investment spending will
increase the economy's equilibrium GDP by $100 billion.
20) If consumers become more optimistic about the future, the level of equilibrium output in the
economy will tend to rise.
21) If interest rates rise, investment spending is likely to increase, shifting the total expenditures
function upward and increasing the equilibrium level of GDP.
22) If the equilibrium level of GDP is $1,000 billion and the economy's full-employment output
is $1,200 billion, a recessionary gap exists.
Question Status: Previous Edition
23) If a recessionary gap exists, the economy cannot be experiencing full employment.
24) If the equilibrium level of GDP is $1,500 billion and the economy's full-employment output
is $1,000 billion, a recessionary gap of $500 billion exists.
25) The formula for calculating the size of the multiplier is 1/1 - MPS.
26) If an economy's MPC is equal to 0.75, the MPS must be 0.25.
27) The consumption function graphs as a 45-degree line from the origin.
28) If the consumption function was graphed as a 45-degree line from the origin, the marginal
propensity to consume would equal 1.00.
29) The marginal propensity to consume is equal to the slope of the consumption function.
30) The rate of interest and the level of investment spending are inversely related, ceteris
paribus.
31) Studies show that the size of the multiplier for the U.S. economy is about 5.0.
32) At the income level where the consumption function crosses the 45-degree line, consumers
plan to spend everything they earn and save nothing.
33) According to Keynesians, the appropriate discretionary fiscal policy for a period of
unemployment would be for the federal government to increase the level of government
spending or cut taxes.
Question Status: Previous Edition
34) Keynesians believe that when inflation exists, taxes should be cut to enable households to
keep up with inflation.
35) According to Keynesians, increased spending for roads and infrastructure would be a
sensible policy during a period of unemployment.
36) Suppose the economy is in equilibrium at a GDP of $1,000 billion. If the economy's MPC is
0.8, the addition of $50 of government spending would raise the equilibrium output to $1,200
billion.
37) When taxes are increased, the total expenditures curve shifts to the right.
38) If the economy's MPS is 0.25, a $100 billion increase in taxes will reduce the economy's
equilibrium output by $400 billion.
39) Assuming an MPC of 0.60, a $20 billion reduction in government spending would lower the
economy's equilibrium output by $50 billion.
40) With an MPC of 0.75, a $40 billion tax reduction would raise equilibrium GDP by $120
billion.
41) Suppose the economy's full employment output is $1,500 billion and MPC is 0.75. If the
equilibrium output is $1,200 billion, government spending must be increased by $300 billion to
achieve full employment.
42) Assume the economy's full employment output is $1,500 billion and MPC is 0.75. If the
equilibrium output is $1,200 billion, government spending must be increased by $75 billion to
achieve full employment.
43) Assume the economy's full employment output is $1,000 billion and MPC is 0.80. If the
equilibrium output is $1,200 billion, government spending must be increased by $50 billion to
achieve full employment.
44) Suppose the economy's full employment output is $1,000 billion and MPC is 0.80. If the
equilibrium output is $760 billion, taxes must be reduced by $60 billion to achieve full
employment.
45) If the federal government simultaneously reduced taxes and government spending by $200
billion, the net effect would be to reduce the economy equilibrium GDP by $200 billion.
46) A tax reduction of $100 billion has a larger effect on the economy's equilibrium GDP than an
increase in government spending of the same size.
47) If the federal government were to increase both taxes and government spending by the same
amount, the equilibrium level of GDP would be unchanged.
48) Suppose that government decided to increase both taxes and government spending by $10
billion. The net effect of these two policies taken together would be to expand the economy's
equilibrium GDP by $10 billion.
49) A tax reduction of $50 billion would have a smaller impact on equilibrium GDP than a $50
increase in government spending.
50) A tax reduction of $20 billion would have a smaller impact on equilibrium GDP than a $20
increase in government spending because a portion of the tax reduction would be saved.
1) According to Keynes, the major cause of fluctuations in the level of total spending in the
economy is changes in the rate of investment spending. Why is the level of investment spending
so unstable or volatile?
2) Discuss the role of inventory changes in pushing the economy toward the equilibrium level of
real GDP.
3) Explain the difference between equilibrium output and full employment equilibrium.
Represent these differences graphically and fully explain your graphs.
4) Suppose the economy is in equilibrium at an output of $1,000 billion. Now suppose that
interest rates rise significantly. Discuss the likely impact of this change on the level of
equilibrium GDP in the economy including an explanation of why it has this impact. Supplement
your explanation with the relevant graph or graphs.
5) Why does the multiplier effect tend to be larger, the greater the economy's marginal
propensity to consume? Don't confine your answer to an explanation of the mathematical
computation of the size of the multiplier; look behind the calculations and explain what's actually
happening in the economy.
6) (Appendix Question) Back in 1995, politicians of both parties were proposing tax cuts even
though the economy was operating near full employment. Some pledged to offset their tax cuts
with equal-sized cuts in government spending. What impact would such a combination of cuts
have on the economy's equilibrium level of GDP? Defend your conclusion.
7) (Appendix Question) Suppose the economy's full-employment equilibrium is $2,000 billion
and the MPC is 0.75. The economy is presently in equilibrium at an output of $1,700 billion.
(a) What is the size of the recessionary gap?
(b) How much must government spending be increased to eliminate unemployment?
(c) How much must taxes be cut to restore full employment? Show your work.
