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Questions and Answers
What is the formula for calculating the multiplier?
What is the formula for calculating the multiplier?
An increase in government spending will always lead to an increase in GDP.
An increase in government spending will always lead to an increase in GDP.
True
If the marginal propensity to consume (MPC) is 0.5, what is the multiplier value?
If the marginal propensity to consume (MPC) is 0.5, what is the multiplier value?
2
The formula for the tax multiplier is $\frac{-MPC}{1 - _____}$
The formula for the tax multiplier is $\frac{-MPC}{1 - _____}$
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Match the type of multiplier with its formula:
Match the type of multiplier with its formula:
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What is the largest source of tax revenue for the government?
What is the largest source of tax revenue for the government?
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Expansionary fiscal policy is aimed at decreasing aggregate demand.
Expansionary fiscal policy is aimed at decreasing aggregate demand.
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What are government transfers?
What are government transfers?
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The formula for GDP is _____ = C + I + G + X - IM.
The formula for GDP is _____ = C + I + G + X - IM.
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Match the following programs to their descriptions:
Match the following programs to their descriptions:
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Which of the following is a component of contractionary fiscal policy?
Which of the following is a component of contractionary fiscal policy?
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Ricardian Equivalence suggests that government budget deficits do not affect private spending.
Ricardian Equivalence suggests that government budget deficits do not affect private spending.
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Name one major category of government spending.
Name one major category of government spending.
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What does expansionary monetary policy aim to achieve?
What does expansionary monetary policy aim to achieve?
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Contractionary monetary policy increases the money supply.
Contractionary monetary policy increases the money supply.
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What effect does lowering the interest rate have on investment spending?
What effect does lowering the interest rate have on investment spending?
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Which of the following is not one of the three key entities of the Federal Reserve System?
Which of the following is not one of the three key entities of the Federal Reserve System?
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Expansionary monetary policy leads to a(n) ______ in consumer spending.
Expansionary monetary policy leads to a(n) ______ in consumer spending.
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Fiat money is backed by a physical commodity like gold.
Fiat money is backed by a physical commodity like gold.
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Match the following monetary policy terms with their correct outcomes:
Match the following monetary policy terms with their correct outcomes:
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What is a primary function of money?
What is a primary function of money?
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M1 includes currency in circulation and __________ bank deposits.
M1 includes currency in circulation and __________ bank deposits.
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What is the end goal of contractionary monetary policy?
What is the end goal of contractionary monetary policy?
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The Fed increases the money supply to lower interest rates.
The Fed increases the money supply to lower interest rates.
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Match the type of money with its definition:
Match the type of money with its definition:
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Which measure of money supply includes savings deposits?
Which measure of money supply includes savings deposits?
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What happens to interest rates during an expansionary monetary policy?
What happens to interest rates during an expansionary monetary policy?
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Banks primarily deal with illiquid assets to finance liquid investments.
Banks primarily deal with illiquid assets to finance liquid investments.
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What do banks do with liquid assets?
What do banks do with liquid assets?
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What effect does growth in money supply generally have on inflation?
What effect does growth in money supply generally have on inflation?
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A negative output gap occurs when the actual unemployment rate is below the natural rate.
A negative output gap occurs when the actual unemployment rate is below the natural rate.
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What does Okun's Law state about the relationship between output gap and unemployment rate?
What does Okun's Law state about the relationship between output gap and unemployment rate?
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A positive inflationary gap indicates that the actual unemployment rate is below the ________ rate.
A positive inflationary gap indicates that the actual unemployment rate is below the ________ rate.
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Match the following concepts with their descriptions:
Match the following concepts with their descriptions:
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What is one of the problems associated with the zero lower bound?
What is one of the problems associated with the zero lower bound?
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The Taylor rule is only forward-looking regarding inflation.
The Taylor rule is only forward-looking regarding inflation.
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What is the primary goal of quantitative easing?
What is the primary goal of quantitative easing?
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The highest inflation in the 21st century is noted in __________.
The highest inflation in the 21st century is noted in __________.
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Match the economic term with its definition:
Match the economic term with its definition:
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What effect does an increase in the money supply generally have on inflation?
What effect does an increase in the money supply generally have on inflation?
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Money supply growth can lead to an increase in price levels in the long run.
Money supply growth can lead to an increase in price levels in the long run.
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What is one reason government printing money can be problematic?
What is one reason government printing money can be problematic?
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The __________ rule uses both current and forecast inflation data in policymaking.
The __________ rule uses both current and forecast inflation data in policymaking.
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Match the following effects with their associated economic concepts:
Match the following effects with their associated economic concepts:
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Study Notes
Fiscal Policy
- Fiscal policy involves government spending and tax revenue.
- Government transfers are payments to households without goods/services in return.
- Social insurance programs are designed to protect families against economic hardship (e.g., social security, Medicare, Medicaid).
- The Affordable Care Act is a significant piece of legislation impacting tax revenue and healthcare access.
Sources of Tax Revenue
- Personal income tax is the largest source of tax revenue.
- Social insurance taxes, corporate profit taxes, and other taxes contribute to the overall tax revenue.
Government Spending
- Government purchases, focusing on national defense and education, are a major component.
- Government transfers (e.g., social security, Medicare, Medicaid) are also part of total government spending.
GDP Formula
- GDP = C + I + G + X - IM.
- Government spending (G) influences household income (C) and business investment (I) through taxes and regulations. This can shift AD (Aggregate Demand) curves.
Fiscal Policy and AD Curve Shifts
- Fiscal policy uses taxes, government transfers, or government purchases to shift the AD curve.
- Expansionary fiscal policy increases aggregate demand, often used during recessions. This can involve increasing government purchases, cutting taxes, or increasing government transfers.
- Contractionary fiscal policy reduces aggregate demand, used to combat inflation. This can involve reducing government purchases, raising taxes, or reducing government transfers.
Expansionary Fiscal Policy
- Increases government purchases of goods/services.
- Cuts taxes.
- Increases government transfers.
Contractionary Fiscal Policy
- Reduces government purchases of goods/services.
- Raises taxes.
- Reduces government transfers.
Multiplier Effect
- An increase in government spending can have a larger impact on GDP than the initial amount spent.
- This is because the government spending leads to increased income for individuals, who in part, spend this income on goods and services. This increase in spending then further increases income and spending, leading to a multiplier effect.
- This multiplier effect is influenced by the marginal propensity to consume (MPC).
The Budget Balance
- Budget balance (Sgovt.) = Taxes (T) - Government Spending (G) - Government Transfers (TR).
- A positive budget balance represents a surplus; a negative one represents a deficit.
Cyclical Adjusted Budget Balance
- A better measure of the budget balance that reflects potential output.
Monetary Policy
US Central Bank
- The Federal Reserve is the central bank.
Key Entities
- Federal Reserve Board of Governors
- 12 Federal Reserve Banks
- Federal Open Market Committee
Key Vocabulary
- Money
- Currency in Circulation
- Checkable Bank Deposits
- Money Supply
Types of Money
- Commodity money (e.g., gold, silver)
- Commodity-backed money (e.g., paper money backed by gold)
- Fiat money (e.g., modern paper currency)
What Banks Do
- Financial intermediaries that use liquid assets to finance the investment of borrowers, also create money.
The Banking System
- Fractional reserve banking is the practice where banks hold a portion of deposits as reserves and loan out the rest. This practice allows the banking system to create money.
Limits to Bank Regulation
- Shadow banking refers to financial institutions that operate outside traditional banking regulations yet perform similar banking functions.
How Banks Create Money
- When someone deposits money into a bank account, the bank holds part of it in reserve and lends out the rest. This process can create additional money in the economy as loans are paid out and redeposited.
Monetary Base
- All currency in circulation, plus the reserves held by banks.
The Money Multiplier
- The amount of money creation that results from a monetary base increase.
Open Market Operations
- The buying and selling of government securities (bills) by the Federal Reserve to control the money supply.
- Buying securities increases reserves and the money supply.
- Selling securities decreases reserves and the money supply.
Target vs. Market
- The market determines interest rates; the Fed aims to manage the money supply to achieve a target interest rate.
Expansionary Monetary Policy
- Increases the money supply to lower interest rates, and stimulates aggregate demand.
Contractionary Monetary Policy
- Decreases the money supply, increases interest rates, and reduces aggregate demand.
Money Demand Curve
- Shows the relationship between money demand and interest rate.
Shifts in Money Demand
- Changes in aggregate price level, real GDP, and technology affect the money demand shifts.
How the Fed Controls Interest Rate
- The money supply impacts the interest rate.
Target Fed Funds Rate
- The ideal Fed funds rate, which will be achieved through open market operations.
Fiscal Policy and Monetary Policy Interactions
- These policies influence output, inflation, and unemployment.
Inflation Targeting
- Central banks set explicit targets for the inflation rate and use monetary policy accordingly.
- Taylor Rule is the typical way to achieve the inflation target.
Zero Lower Bound
- Interest rates cannot fall below zero, potentially limiting the effectiveness of monetary policy.
Money Neutrality
- In the long run, money supply changes do not affect real variables like output.
Inflation and Money Supply
- In general, inflation and the money supply move together.
- Governments can experience inflation resulting from increasing the rate at which money supply is created
Okun's Law
- Negative relationship between the output gap and the unemployment rate.
Short-Run Phillips Curve
- Negative relationship between the unemployment rate and the inflation rate (in the short run).
Supply Shocks and Inflation Expectations
- Supply shocks and changing inflation expectations can shift the short-run Phillips curve.
Long-Run Phillips Curve
- Relationship between unemployment and inflation rate after expectations have had time to adjust.
- Non-accelerating inflation rate of unemployment (NAIRU) is the rate at which inflation does not accelerate.
Natural Rate Hypothesis
- The long-run Phillips curve is vertical, and the unemployment rate is determined by factors other than monetary policy.
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Description
This quiz dives into the key concepts of fiscal policy, including government spending, tax revenue sources, and the impact of legislation like the Affordable Care Act. It also covers the GDP formula and how government actions influence economic factors. Test your understanding of these essential economic principles.
