Question 1

What is the Ricardian Equivalence Theorem and why is it important to debates about fiscal policy?

Accepted Answer

David Ricardo's Ricardian Equivalence Theorem stated that government spending financed by selling government bonds (the government running a budget deficit)was no different from government spending financed by taxes (the government running a balanced budget).Government would have to increase taxes in the future both to pay the interest on the bonds and to repay the bonds when they came due.Assuming people can borrow and save,and thereby shift spending between now and the future,people would save more now to pay for those future taxes.So,there is no reason why deficit financed spending should affect the aggregate level of income differently than tax financed spending.It followed that a government deficit would not lead to an expansion of output in the economy.This theoretical proposition that deficits do not affect the level of output in the economy because individuals will increase their savings to account for expected future tax payments to repay the deficit has become known as the Ricardian Equivalence Theorem.
Based on Ricardian equivalence,some have argued that whether a government deficit is financed by bonds (deficit spending)or by taxes (balanced budget)is irrelevant.The method of funding government spending does not affect aggregate output.

Question 2

When the government runs a deficit it must:

Accepted Answer

A) buy bonds to finance the deficit. 
B) sell bonds to finance the deficit. 
C) decrease the money supply to finance the deficit. 
D) raise taxes immediately. 
A) buy bonds to finance the deficit. 
B) sell bonds to finance the deficit. 
C) decrease the money supply to finance the deficit. 
D) raise taxes immediately. B

Question 3

According to the Ricardian equivalence theorem, government deficits do not affect output because people:

Accepted Answer

A) save more when government deficits decrease. 
B) save more when government deficits increase. 
C) consume more when government deficits increase. 
D) do not change consumption nor savings. 
A) save more when government deficits decrease. 
B) save more when government deficits increase. 
C) consume more when government deficits increase. 
D) do not change consumption nor savings. B

Question 4

Contractionary fiscal policy that reduces the budget deficit may:

Accepted Answer

A) reduce business investment by increasing interest rates. 
B) reduce business investment by reducing interest rates. 
C) increase business investment by increasing interest rates. 
D) increase business investment by reducing interest rates. 
A) reduce business investment by increasing interest rates. 
B) reduce business investment by reducing interest rates. 
C) increase business investment by increasing interest rates. 
D) increase business investment by reducing interest rates.

Question 5

An economist who follows a functional finance principle believes that the government should:

Accepted Answer

A) do nothing in response to a recession. 
B) do nothing in response to a recession due to the Ricardian equivalence theorem. 
C) run either a deficit or surplus depending on the state of the economy. 
D) run a balanced budget. 
A) do nothing in response to a recession. 
B) do nothing in response to a recession due to the Ricardian equivalence theorem. 
C) run either a deficit or surplus depending on the state of the economy. 
D) run a balanced budget.

Question 6

Suppose the government increases spending by $30 billion and raises taxes by $20 billion at the same time. Then:

Accepted Answer

A) interest rates will most likely stay the same. 
B) interest rates will most likely increase. 
C) business investment is not likely to change. 
D) business investment is likely to increase due to crowding out. 
A) interest rates will most likely stay the same. 
B) interest rates will most likely increase. 
C) business investment is not likely to change. 
D) business investment is likely to increase due to crowding out.

Question 7

What is meant by "functional finance"?

Accepted Answer

Functional finance holds that as a theor

Question 8

What is the crowding out effect? Using the AS/AD model,demonstrate graphically and explain in words the impact of expansionary fiscal policy on the crowding out effect.

Accepted Answer

The crowding out effect is the offsettin

Question 9

The government's running of a deficit or a surplus with the objective of affecting the level of output in the economy is called:

Accepted Answer

A) public finance. 
B) fiscal policy. 
C) the Ricardian equivalence. 
D) sound finance. 
A) public finance. 
B) fiscal policy. 
C) the Ricardian equivalence. 
D) sound finance.

Question 10

According to the Ricardian equivalence theorem, people increase savings when the government increases deficits because they recognize the link between government deficits and higher future taxes.

Accepted Answer

A) True 
 B)False

Question 11

Most of the government budget is mandatory spending through programs like Medicare and Social Security, and much of the rest is politically difficult to alter. Because of this:

Accepted Answer

A) fiscal policy is always undertaken only when there is a national crisis that motivates voters to seek change. 
B) fiscal policy that involves raising taxes is more likely to be implemented than fiscal policy that involves borrowing money. 
C) the amount of spending is unlikely to be implemented as economists suggest. 
D) most spending is geared to perform as an automatic stabilizer, so that Congress is in fact largely irrelevant when it comes to providing a fiscal response to a recession. 
A) fiscal policy is always undertaken only when there is a national crisis that motivates voters to seek change. 
B) fiscal policy that involves raising taxes is more likely to be implemented than fiscal policy that involves borrowing money. 
C) the amount of spending is unlikely to be implemented as economists suggest. 
D) most spending is geared to perform as an automatic stabilizer, so that Congress is in fact largely irrelevant when it comes to providing a fiscal response to a recession.

Question 12

During an economic expansion, automatic stabilizers:

Accepted Answer

A) reduce both budget surpluses and deficits. 
B) reduce a budget surplus or increase a deficit. 
C) reduce a budget deficit or increase a surplus. 
D) increase both budget surpluses and deficits. 
A) reduce both budget surpluses and deficits. 
B) reduce a budget surplus or increase a deficit. 
C) reduce a budget deficit or increase a surplus. 
D) increase both budget surpluses and deficits.

Question 13

An example of a procyclical fiscal policy is:

Accepted Answer

A) an income tax. 
B) unemployment compensation. 
C) a balanced budget policy. 
D) welfare payments. 
A) an income tax. 
B) unemployment compensation. 
C) a balanced budget policy. 
D) welfare payments.

Question 14

If an economy is above potential output and the government opts for a contractionary fiscal policy (running surpluses)to shift the AD curve, an economist with a Classical view, who holds the Ricardian equivalence theorem to be practically true, would conclude that the AD curve:

Accepted Answer

A) shifts to the right due to lower government spending. 
B) shifts to the left due to lower government spending. 
C) does not shift since the lower government spending is offset by higher private consumption. 
D) does not shift since the lower government spending is offset by lower private consumption. 
A) shifts to the right due to lower government spending. 
B) shifts to the left due to lower government spending. 
C) does not shift since the lower government spending is offset by higher private consumption. 
D) does not shift since the lower government spending is offset by lower private consumption.

Question 15

If private investment is relatively sensitive to interest rates, then a fiscal expansion financed by government bond sales will:

Accepted Answer

A) have no effect on output. 
B) raise output by a relatively small amount. 
C) raise output by a relatively large amount. 
D) have an ambiguous effect on output. 
A) have no effect on output. 
B) raise output by a relatively small amount. 
C) raise output by a relatively large amount. 
D) have an ambiguous effect on output.

Question 16

Why did proponents of sound finance oppose deficit spending?

Accepted Answer

Proponents of sound finance accepted Ric

Question 17

Fiscal policy would be more effective if:

Accepted Answer

A) potential income was unknown. 
B) the government could change taxes and expenditures rapidly. 
C) the size of the government debt didn't matter. 
D) crowding out occurred more often. 
A) potential income was unknown. 
B) the government could change taxes and expenditures rapidly. 
C) the size of the government debt didn't matter. 
D) crowding out occurred more often.

Question 18

When the economy is experiencing inflation, an economist who follows the functional finance theorem is most likely to suggest that the government should:

Accepted Answer

A) do nothing. 
B) run a deficit. 
C) run a surplus. 
D) run a balanced budget. 
A) do nothing. 
B) run a deficit. 
C) run a surplus. 
D) run a balanced budget.

Question 19

Refer to the graph shown. Suppose the government borrows $50 million to finance an increase in its spending and that as a result, the level of investment is reduced by $50 million. In this case, the aggregate demand curve will:

Accepted Answer

A) shift from AD0 to AD2 but then back to AD1. 
B) shift from AD0 to AD2 but then out to AD3. 
C) shift from AD0 to AD2. 
D) not shift. 
A) shift from AD0 to AD2 but then back to AD1. 
B) shift from AD0 to AD2 but then out to AD3. 
C) shift from AD0 to AD2. 
D) not shift.

Question 20

If the government knew the level of potential income and had sufficient information about the economy it could fine-tune the economy.

Accepted Answer

A) True 
 B)False

Exam 32: The Fiscal Policy Dilemma

What is the Ricardian Equivalence Theorem and why is it important to debates about fiscal policy?

When the government runs a deficit it must:

According to the Ricardian equivalence theorem, government deficits do not affect output because people:

Contractionary fiscal policy that reduces the budget deficit may:

An economist who follows a functional finance principle believes that the government should:

Suppose the government increases spending by $30 billion and raises taxes by $20 billion at the same time. Then:

What is meant by "functional finance"?

What is the crowding out effect? Using the AS/AD model,demonstrate graphically and explain in words the impact of expansionary fiscal policy on the crowding out effect.

The government's running of a deficit or a surplus with the objective of affecting the level of output in the economy is called:

According to the Ricardian equivalence theorem, people increase savings when the government increases deficits because they recognize the link between government deficits and higher future taxes.

Most of the government budget is mandatory spending through programs like Medicare and Social Security, and much of the rest is politically difficult to alter. Because of this:

During an economic expansion, automatic stabilizers:

An example of a procyclical fiscal policy is:

If an economy is above potential output and the government opts for a contractionary fiscal policy (running surpluses)to shift the AD curve, an economist with a Classical view, who holds the Ricardian equivalence theorem to be practically true, would conclude that the AD curve:

If private investment is relatively sensitive to interest rates, then a fiscal expansion financed by government bond sales will:

Why did proponents of sound finance oppose deficit spending?

Fiscal policy would be more effective if:

When the economy is experiencing inflation, an economist who follows the functional finance theorem is most likely to suggest that the government should:

Refer to the graph shown. Suppose the government borrows $50 million to finance an increase in its spending and that as a result, the level of investment is reduced by $50 million. In this case, the aggregate demand curve will:

If the government knew the level of potential income and had sufficient information about the economy it could fine-tune the economy.

Economics and Economic Reasoning

The Production Possibility Model, Trade, and Globalization

Economic Institutions

Supply and Demand

Using Supply and Demand

Describing Supply and Demand: Elasticities

Taxation and Government Intervention

Market Failure Versus Government Failure

Comparative Advantage, Exchange Rates, and Globalization

International Trade Policy

Production and Cost Analysis I

Production and Cost Analysis II

Perfect Competition

Monopoly and Monopolistic Competition

Oligopoly and Antitrust Policy

Real-World Competition and Technology

Work and the Labor Market

Who Gets What the Distribution of Income

The Logic of Individual Choice: the Foundation of Supply and Demand

Game Theory, Strategic Decision Making, and Behavioral Economics

Thinking Like a Modern Economist

Behavioral Economics and Modern Economic Policy

Microeconomic Policy, Economic Reasoning, and Beyond

Economic Growth, Business Cycles, and Unemployment

Measuring and Describing the Aggregate Economy

The Keynesian Short-Run Policy Model: Demand-Side Policies

The Classical Long-Run Policy Model: Growth and Supply-Side Policies

The Financial Sector and the Economy

Monetary Policy

Financial Crises, Panics, and Unconventional Monetary Policy

Deficits and Debt: the Austerity Debate

Jobs and Unemployment

Inflation, Deflation, and Macro Policy

International Financial Policy

Macro Policy in a Global Setting

Structural Stagnation and Globalization

Macro Policy in Developing Countries

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