Fiscal Policy and Automatic Stabilizers Review

Which of the following statements best describes the concept of an automatic stabilizer?

• It is non-discretionary fiscal policy that mitigates business cycles by increasing aggregate demand during recessions and decreasing aggregate demand during expansions.

• It is discretionary fiscal policy that increases government spending during recessions and decreases government spending during expansions.

• It is a measure of the effect that a change in government spending and investment has on the gross domestic product.

• It is a description of how total income is always equal to total expenditures as a measure of gross domestic product.

• It is the process whereby surpluses lead to falling prices and shortages lead to rising prices to stabilize market equilibrium.

Answer explanation

Automatic stabilizers are tax and spending programs that counteract the business cycle by increasing aggregate demand during recessions and decreasing aggregate demand during expansions without intervention by the government or policy makers.

Which of the following is an example of an automatic stabilizer?

• Discretionary fiscal policy

• Progressive income taxes

• Autonomous consumption

• The spending multiplier

• Cyclical unemployment

Answer explanation

Automatic stabilizers are tax and spending programs that counteract the business cycle by increasing aggregate demand during recessions and decreasing aggregate demand during expansions without intervention by the government or policy makers. Progressive income taxes are an example of an automatic stabilizer because individual income-tax payments will fall when incomes fall during recessions, thereby stimulating aggregate demand without any discretionary policy actions being taken, and rise when incomes rise during expansions, thereby contracting aggregate demand without any discretionary policy.

Which of the following is an example of an expansionary fiscal policy?

• An increase in income tax rates

• An increase in government expenditures

• A decrease in transfer payments

• An increase in the price level

• An increase in consumption spending

Answer explanation

An increase in government expenditures is an expansionary fiscal policy. An expansionary fiscal policy is a policy aimed at increasing aggregate demand, such as increasing government expenditures, decreasing taxes, and increasing transfer payments.

If there is an inflationary gap, which of the following changes will move the economy back toward full employment?

• An increase in investment spending

• An increase in government spending

• An increase in taxes

• An increase in exports

• An increase in transfer payments

Answer explanation

An increase in taxes will decrease disposable income, which will decrease consumption and decrease aggregate demand, moving the economy back toward full employment.

Recessions will most likely be less severe if tax revenues and transfer payments automatically change in which of the following ways?

• Tax revenues increase, and transfer payments increase.

• Tax revenues decrease, and transfer payments decrease.

• Tax revenues increase, and transfer payments decrease.

• Tax revenues decrease, and transfer payments increase.

• Tax revenues do not change, and transfer payments decrease.

Answer explanation

A decrease in tax revenues and an increase in transfers would mitigate a recession by preventing consumption from declining further.

If a nation’s government cuts income taxes, how will consumption spending, real output, and unemployment change in the short run?

• Consumption spending will increase, real output will increase, and unemployment will decrease.

• Consumption spending will increase, real output will decrease, and unemployment will decrease.

• Consumption spending will decrease, real output will decrease, and unemployment will increase.

• Consumption spending, real output, and unemployment will all decrease.

• Consumption spending, real output, and unemployment will all increase.

Answer explanation

Tax cuts increase disposable income and therefore increase consumption spending, which increases aggregate demand and real output. When real output increases, unemployment decreases.

Who is in charge of fiscal policy?

• Government
• Federal Reserve

Which of the following are responsible for making fiscal policy decision? 

• The President and Congress
• The Federal Reserve System
• The National Council of Economic Advisors
• The commerce Department

Taxing & spending to help the economy grow is referred to as

• expansionary policy
• monetary policy
• contractionary policy
• budget deficit

Taxing & spending to slow the economy is referred to as 

• budget surplus 
• monetary policy
• contractionary policy
• budget deficit