Keynesian Fiscal Policy Practice Test and Answer Key, 2015

Keynesian Fiscal Policy Practice Test, March 2015 Keynesian Fiscal Policy Practice Test

Multiple Choice (13 marks)

------Fiscal Policy ------

1. If income increases by $100.00, consumption increases by $30.00. Based on this information, we can actually determine: a) the marginal propensity to consume; b) the marginal propensity to save; c) the spending multiplier; d) the taxation multiplier; e) all of the above.

2. Income increases by $100.00, causing consumption to increase by $30.00. Based on this information, the marginal propensity to consume is: a) 70% b) – 0.3 c) – 70% d) 0.7 e) none of the above

3. Income increases by $100.00, causing consumption to increase by $30.00. Based on this information, the marginal propensity to save is: a) 70% b) – 0.3 c) – 70% d) 0.7 e) a and d

4. Income increases by $100.00, causing consumption to increase by $30.00. Based on this information, the spending multiplier is: a) 1.43 b) 2.33 c) 3.33 d) 3.67 e) none of the above

Keynesian Fiscal Policy Practice Test, March 2015 5. Income increases by $100.00, causing consumption to increase by $30.00. Based on this information, the taxation multiplier is: a) – 0.33 b) – 0.43 c) – 0.67 d) – 1.00 e) none of the above

6. The Keynesian Cross describes a model where equilibrium occurs at the point where: a) MD = MS b) AD = Real GDP c) AS = AD d) S = D e) none of the above

7. Keynes was worried, more than anything else, about: a) the fact that monetary policy wouldn’t work to increase GDP, b) the fact that people would tend to hoard money during a recession, c) the fact that governments would try to spend money to increase GDP; d) the fact that government spending would cause deficits; e) none of the above.

8. If the MPC is 0.6, then the multiplier must be: a) 2.0 b) 2.5 c) 3.0 d) 3.5 e) 4.0

9. If the government spends 10 million and the multiplier is 5, then real GDP will increase by: a) nothing b) 10 million c) 50 million d) 100 million e) none of the above.

10. If the government spends 10 million, taxes 10 million, and the multiplier is 5, then real GDP will increase by: a) nothing b) 10 million c) 50 million d) 100 million e) none of the above. Keynesian Fiscal Policy Practice Test, March 2015

11. Based on the diagram shown, the autonomous expenditure in this economy is: a) 100 b) 200 c) 300 d) 400 e) 500

12. Based on the diagram shown, the equilibrium level of income is: a) 300 b) 400 c) 800 d)1000 e) none of the above

13. Based on the diagram shown, the multiplier is: a) 1.0 b) 2.0 c) 3.0 d) 4.0 e) 5.0

Keynesian Fiscal Policy Practice Test, March 2015

Section B: Written Response Answer any TWO of the following four questions. (8 marks)

1. Explain how Adam Smith and John Maynard Keynes fundamentally disagreed about the issue of long- run economic equilibrium.

2. Explain John Maynard Keynes’ theory about the balanced budget multiplier.

3. Explain John Maynard Keynes’ perspective about what he called the “autonomous expenditure” within an economy.

4. Explain the forces that John Maynard Keynes believed pushed the economy toward the long-run equilibrium level of income.

#__ .______

______

#__ .______

______

Keynesian Fiscal Policy Practice Test, March 2015 Measures of Macroeconomic Performance Crossword (10 marks)

2 6

Across: Down:

1. The multiplier is calculated by dividing 2. Keynes believed that economic one by the marginal propensity to ____. equilibrium could occur at ANY level of 4. This describes an economy that is output, as long as total production is equal experiencing inflation during a recession. to aggregate ____. 5. Classical economists feel the economy 3. Keynes believed that an economy would will be at equilibrium when at full ___. spend a certain amount of money EVEN if 7. Classical economists believed the the economy was generating no income economy would always be corrected as long (GDP) at all. He called this the ____ as this was flexible. expenditure. 6. This describes the fact that the same money is respent several times within the economy. 4. Keynes did not believe the economy would always correct itself because he thought prices were ____.

Keynesian Fiscal Policy Practice Test, March 2015 ANSWER KEY

Multiple Choice (13 marks)

2. Income increases by $100.00, causing consumption to increase by $30.00. Based on this information, the marginal propensity to consume is: a) 70% b) – 0.3 c) – 70% d) 0.7 *e) none of the above

3. Income increases by $100.00, causing consumption to increase by $30.00. Based on this information, the marginal propensity to save is: a) 70% b) – 0.3 c) – 70% d) 0.7 *e) a and d

4. Income increases by $100.00, causing consumption to increase by $30.00. Based on this information, the spending multiplier is:

*a) 1.43 b) 2.33 c) 3.33 d) 3.67 e) none of the above

5. Income increases by $100.00, causing consumption to increase by $30.00. Based on this information, the taxation multiplier is: a) – 0.33 *b) – 0.43 c) – 0.67 d) – 1.00 e) none of the above Keynesian Fiscal Policy Practice Test, March 2015

6. The Keynesian Cross describes a model where equilibrium occurs at the point where: a) MD = MS *b) AD = Real GDP c) AS = AD d) S = D e) none of the above

7. Keynes was worried, more than anything else, about: a) the fact that monetary policy wouldn’t work to increase GDP, *b) the fact that people would tend to hoard money during a recession, c) the fact that governments would try to spend money to increase GDP; d) the fact that government spending would cause deficits; e) none of the above.

8. If the MPC is 0.6, then the multiplier must be: a) 2.0 *b) 2.5 c) 3.0 d) 3.5 e) 4.0

9. If the government spends 10 million and the multiplier is 5, then real GDP will increase by: a) nothing b) 10 million *c) 50 million d) 100 million e) none of the above.

10. If the government spends 10 million, taxes 10 million, and the multiplier is 5, then real GDP will increase by: a) nothing *b) 10 million c) 50 million d) 100 million e) none of the above.

Keynesian Fiscal Policy Practice Test, March 2015

11. Based on the diagram shown, the autonomous expenditure in this economy is: a) 100 b) 200 *c) 300 d) 400 e) 500

12. Based on the diagram shown, the equilibrium level of income is: a) 300 *b) 400 c) 800 d)1000 e) none of the above

13. Based on the diagram shown, the multiplier is:

*a) 1.3 b) 2.0 c) 3.0 d) 4.0 e) 5.0

Keynesian Fiscal Policy Practice Test, March 2015 Section B: Written Response Answer any TWO of the following four questions. (8 marks)

1. Explain how Adam Smith and John Maynard Keynes fundamentally disagreed about the issue of long- run economic equilibrium.

Adam Smith believed the economy would naturally move toward an equilibrium at full employment, as he believed that surplus factors of production (unemployed resources) would create downward pressure on prices, and these lower prices would encourage more consumption and more production.

John Keynes, on the other hand, believed that if aggregate demand were low, then the economy could stall at a level of output that was below full employment output. He believed this could happen because not all surplus factors of production would necessarily compete with other factors in the factor market. Unemployed plumbers, for example, would not compete with engineers. Thus, in a specialized world, wages of employed people can become “sticky,” and less prone to falling simply because some other people are unemployed.

2. Explain John Maynard Keynes’ theory about the balanced budget multiplier.

Keynes believed that a balanced budget wherein government taxation was equal to government spending, would bring abut an increase in real output equal to the amount of the budget. Thus, $20 million of government taxation and $20 million of government sending would bring about a $20 million increase in real GDP.

3. Explain John Maynard Keynes’ perspective about what he called the “autonomous expenditure” within an economy.

Autonomous expenditure - required to fund necessities - exists regardless of any income at all. In other words, it is the theoretical amount of aggregate expenditure that will exist even if the economy is not earning any income at all. This expenditure counts as dissaving, because it is financed by either borrowing money or by using up savings.

4. Explain the forces that John Maynard Keynes believed pushed the economy toward the long-run equilibrium level of income.

If our aggregate expenditure is greater than the value of our output (income), then we are trying to buy more than we are currently producing, thus creating upward pressure on production. Conversely, if our aggregate expenditure is less than the value of our output (income), then we aren’t buying everything that we are producing, and this will create downward pressure on production. Keynesian Fiscal Policy Practice Test, March 2015

Measures of Macroeconomic Performance Crossword (10 marks)

5E M P L O Y M E N T

U 2D 6M

1S A V E U

M L

4S T A G F L A T I O N

T N I

I D P

C L

K 7P R I C E S

Y E