Macroeconomics Canadian 8th Edition

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MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) What is fiscal policy?

A) It is the use of interest rate policy by the central bank to stabilize an economy.
B) It is the government's approach to its own spending and taxation.
C) It is employed by governments only when the economy is experiencing a recessionary gap.
D) It is the total spending by all levels of government.
E) It is the central bank's approach to interest rate policy.
Answer: B

2) All of the following, except one, are revenue categories in the federal government's budget plan.
Which is the exception?
A) Corporate income taxes.
B) Personal income taxes.
C) GST and excise taxes.
D) E.I. premiums.
E) Revenue from the sale of government bonds.
Answer: E

3) All of the following, except one, are outlays categories in the federal government's budget plan.
Which is the exception?
A) Direct program spending.
B) Public debt charges.
C) International debt charges.
D) Spending grants to other levels of government.
E) Transfers to persons.
Answer: C

4) What is net tax revenue in excess of government spending on goods and services called?
A) A budget deficit. B) Transfer payments.
C) A budget surplus. D) Gross tax revenue.
Answer: C

5) What is government spending on goods and services in excess of net tax revenue called?
A) Monetizing the debt. B) A budget surplus.
C) A budget deficit. D) Pro-cyclical fiscal policy.
Answer: C

6) What is a budget deficit?

A) It is the amount by which federal government spending of all types is below net tax revenues.
B) It is government spending on goods and services in excess of net tax revenue.
C) It is government spending of all types in excess of net tax revenue.
D) It is government spending of all types plus net tax revenues.
Answer: B

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7) What is a balanced budget?
A) It is the equality of tax revenues and government spending on goods and services.
B) It is the absence of government debt.
C) It is a budget where the government spends over many categories in a balanced fashion.
D) It is the equality of net tax revenues and government spending on goods and services
Answer: D

8) Which of the following is a correct statement about the federal government's budget?
A) It has been in a surplus continuously since the 1960s.
B) It has been in a surplus in the last few years after decades of deficits.
C) It has been in a deficit continuously since the 1960s.
D) It has been in a deficit in the last few years after decades of surpluses.
Answer: D

9) What is the national debt?

A) The total amount borrowed domestically and internationally by all levels of government.
B) The sum of the federal government's budget deficits less surpluses.
C) The total amount borrowed domestically by all levels of government.
D) The amount owed by the federal government to the World Bank.
Answer: B

10) Suppose that the government's total tax receipts are $130, government spending on goods and
services is $100 and transfer payments are $40. What is the government's budget surplus or deficit?
A) A deficit of $10. B) A deficit of $30.
C) A surplus of $30. D) A surplus of $10.
Answer: A

11) Suppose that the government's total tax receipts are $130, government spending on goods and
services is $100 and transfer payments are $40. What are net tax revenues?
A) -$10. B) +$70. C) +$90. D) +$30.
Answer: C

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12) Refer tothe graph above to answer this question. Which of the following is true?
A) A balanced budget would occur at income level Y1.
B) A balanced budget could occur at income levels Y1, Y2 or Y3.
C) A balanced budget would occur at income level Y2.
D) The existence of a balanced budget cannot be determined because no information on tax
revenues is given.
Answer: C

13) Refer to
the graph above to answer this question. What do both ab and fg represent?
A) A budget deficit. B) An inflationary gap.
C) A recessionary gap. D) A budget surplus.
Answer: A

14) Refer to
the graph above to answer this question. What do both de and ij represent?
A) A budget deficit. B) A budget surplus.
C) An inflationary gap. D) A recessionary gap.
Answer: B

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15) Refer tothe graph above to answer this question. What does this graph indicate?
A) That the state of the government's budget depends on the level of real GDP as well as on tax
rates and its own spending.
B) That the level of real GDP depends on the slope of the budget line.
C) That net tax revenues, government spending and the government's budget all depend on the
level of real GDP.
D) That real GDP level Y2 is equilibrium GDP.
E) That real GDP level Y2 is both equilibrium GDP and a balanced budget.
Answer: A

16) Refer tothe graph above to answer this question. What does this graph indicate?
A) That government spending is autonomous of real GDP and that net tax revenue is a function of
real GDP.
B) That a balanced budget can occur at any level of real GDP except Y2.
C) That budget surpluses are possible only at lower levels of real GDP.
D) That government spending is a function of real GDP and that net tax revenue is autonomous of
real GDP.
E) That budget deficits are possible only at higher levels of real GDP.
Answer: A

17) Refer to
the graph above to answer this question. What does this graph indicate?
A) That Y2 is the equilibrium level of real GDP.
B) That the budget line is unrelated to NTR.
C) That net tax revenues depend on tax rates but not on the level of real GDP.
D) That government spending and the size of the budget surplus or deficit are unrelated.
E) That Y1, Y2 and Y3 could all be equilibrium levels of real GDP.
Answer: E

18) What determines the state of the government's budget?

A) Both the level of GDP in the economy as well as tax rates and its own spending.
B) Its tax rates and the exchange rate.
C) Its tax rates.
D) The level of its spending.
E) Both the level of GDP in the economy as well as tax rates and the exchange rate.
Answer: A

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19) Refer to the graph to answer this question. Which of the following is verified by the graph?

A) That a budget deficit exists if government spending is G 2 and real GDP is Y1.
B) That the budget is balanced if government spending is G1 and real GDP is Y3 .
C) The reduction in government spending from G1 to G2 would produce real GDP equilibrium at
Y1.
D) If government spending was reduced from G 1 to G2 the budget surplus at Y2 would disappear
if real GDP remained at Y3 .
E) That a budget surplus exists if government spending is G1 and real GDP is Y1 .
Answer: B

20) What iscounter-cyclical fiscal policy?

A) Deliberate adjustments in the level of government spending and taxation in order to close
recessionary or inflationary gaps.
B) Government spending and taxation policy aimed at a balanced budget.
C) Deliberate adjustments in the level of government spending and taxation in order to ensure
equilibrium GDP.
D) Government taxation policy aimed at a balanced budget.
Answer: A

21) What hasbeen the main purpose of fiscal policy, as used by most governments, since WWII?
A) To achieve the twin goals of full employment and a viable balance of payments.
B) To achieve the twin goals of stable prices and a viable balance of payments.
C) To achieve the goal of stable prices.
D) To achieve the goal of full employment.
E) To achieve the twin goals of full employment and stable prices.
Answer: E

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22) Graphically,
what would cause the aggregate demand curve to shift to the right?
A) Counter-cyclical fiscal policy and a recessionary gap.
B) A decrease in government spending on goods and services.
C) Counter-cyclical fiscal policy and an inflationary gap.
D) An increase in net tax revenues.
E) An increase in taxes.
Answer: A

23) Graphically, what happened to the aggregate demand curve during World War II?
A) It shifted to the right leading to a big increase in real GDP but to no change in the price level.
B) It shifted to the left since a big portion of expenditures was diverted to military spending.
C) It did not shift, but the capacity of the economy increased thus shifting the aggregate supply
curve to the left.
D) It shifted to the right thus causing an inflationary gap.
E) It did not shift since the economy was already at capacity.
Answer: D

24) When a recessionary gap exists, what should the government do to address the situation?
A) Increase its own spending and tax rates.
B) Increase its own spending or decrease tax rates.
C) Decrease its own spending or increase tax rates.
D) Decrease its own spending and tax rates.
E) Decrease its own spending but leave tax rates unchanged.
Answer: B

25) What would be appropriate government action to close a recessionary gap?

A) Use policy to decrease potential GDP.
B) Use policy to decrease aggregate supply.
C) Use counter-cyclical fiscal policy to increase aggregate demand.
D) Use counter-cyclical fiscal policy to decrease aggregate demand.
Answer: C

26) Which of the following would help eliminate a recessionary gap?

A) An increase in consumer spending.
B) An increase in government spending
C) An increase in investment.
D) An increase in exports.
E) All of the above.
Answer: E

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27) If the government used counter-cyclical policy to eliminate an inflationary gap, what should it do?
A) Increase its own spending but leave tax rates unchanged.
B) Decrease its own spending and tax rates.
C) Decrease its own spending or increase tax rates.
D) Increase its own spending and tax rates.
E) Increase its own spending or decrease tax rates.
Answer: C

28) What would be appropriate government action to close an inflationary gap?

A) Use policy to decrease potential GDP.
B) Use counter-cyclical fiscal policy to increase aggregate demand.
C) Use policy to decrease aggregate supply.
D) Use counter-cyclical fiscal policy to decrease aggregate demand.
Answer: D

29) Which of the following would help reduce an inflationary gap?

A) An increase in interest rates.
B) A decrease in exports.
C) A decrease in government spending
D) An increase in consumption
E) An increase in tax rates.
Answer: C

30) Which of the following is not a likely outcome of counter-cyclical fiscal policy?
A) It can always be directed at a specific region of the country.
B) It will increase interest rates if used to eliminate an inflationary gap.
C) It will reduce aggregate demand if used to eliminate an inflationary gap.
D) It will likely reduce unemployment if used to eliminate an inflationary gap.
E) It will likely raise the exchange rate if used to eliminate an inflationary gap.
Answer: E

31) What is involved in counter-cyclical fiscal policy?

A) Government spending but not taxes.
B) Higher government spending if used to eliminate a recessionary gap.
C) Lower taxes if used to eliminate an inflationary gap.
D) Higher taxes if used to eliminate a recessionary gap.
E) Higher government spending if used to eliminate an inflationary gap.
Answer: B

32) What will counter-cyclical fiscal policy do?

A) Raise GDP and lower prices if used to eliminate a recessionary gap.
B) Raise GDP, but leave prices unchanged if used to eliminate a recessionary gap.
C) Lower GDP and prices if used to eliminate a recessionary gap.
D) Raise GDP and prices if used to eliminate a recessionary gap.
Answer: D

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33) How can an inflationary gap be closed?
A) By an increase in government spending.
B) By an increase in taxes.
C) By a decrease in aggregate supply.
D) By an increase in the price level.
E) By an increase in aggregate demand.
Answer: B

34) What is true regarding counter-cyclical fiscal policy?

A) It can eliminate the business cycle.
B) It aims to balance the economy not the budget.
C) It has been described as "enhancing the prevailing winds."
D) It reinforces the business cycle.
E) It has no connection with the business cycle.
Answer: B

35) Those who advocate counter-cyclical fiscal policy would agree with all but one of the following
statements. Which is the exception?
A) Automatic stabilizers are not particularly effective.
B) Government budget deficits are a less serious problem than income gaps.
C) The economy is not capable of automatic self-adjustment in response the problems of
unemployment and inflation.
D) Governments should be non-interventionist.
E) Counter cyclical fiscal policy is a powerful and effective tool.
Answer: D

36) Graphically,
which of the following will be the result of counter-cyclical fiscal policy?
A) There will be a movement along both the AS and potential GDP curves.
B) Both the AS and the potential GDP curves will shift.
C) There will be a movement along the AS curve.
D) Only the AS curve will shift.
Answer: C

37) How would you graphically illustrate counter-cyclical fiscal policy used to eliminate an inflationary
gap?
A) A leftward shift in the AD curve.
B) A shift in the AS and the potential GDP curves.
C) A rightward shift in the AD curve.
D) A shift in the AS curve only.
Answer: A

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38) Assume that the economy is in a recession and has a balanced budget. If the government increases
its spending to reduce unemployment, what will happen to GDP and the government's budget?
A) GDP will fall and the budget will be in a surplus.
B) GDP will rise and the budget will be in a deficit.
C) GDP will fall and the budget will be in a deficit.
D) GDP will rise and the budget will be in a surplus.
Answer: B

39) Allof the following, except one, is a criticism of using counter-cyclical fiscal policy during a
recession. Which is the exception?
A) It can cause serious budget deficits.
B) It tends to be inflationary.
C) Its effectiveness is subject to serious time lags.
D) It reinforces the business cycle.
Answer: A

40) All
of the following, except one, would result from expansionary fiscal policy. Which is the
exception?
A) Increased GDP. B) Decreased unemployment.
C) Increased price level. D) Decreased budget deficit.
Answer: D

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41) Refer to
the graph above to answer this question. If this economy is experiencing a recessionary gap,
which of the following could be correct?
A) Real GDP is Y 1 and there is a budget surplus.
B) Real GDP is Y 2 and there is a balanced budget.
C) Real GDP is Y 1 and there is a balanced budget.
D) Real GDP is Y 1 and there is a budget deficit.
Answer: D

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42) Refer tothe graph above to answer this question. Suppose this economy is initially at Y 1 with
budget line BL1. If counter-cyclical fiscal policy is used which of the following is correct?
A) Aggregate demand would decrease from AD2 to AD 1 and the budget surplus would increase
from cd to ab.
B) Aggregate demand would decrease from AD2 to AD 1 and the budget deficit would decrease
from cd to ab.
C) Aggregate demand would increase from AD 1 to AD 2 and the budget surplus would increase
from ab to cd.
D) Aggregate demand would decrease from AD2 to AD 1 and the budget surplus would decrease
from cd to ab.
E) Aggregate demand would increase from AD 1 to AD 2 and the budget deficit would increase
from ab to cd.
Answer: E

43) Refer to
the graph above to answer this question. The shift in the budget line from BL1 to BL2 could
be caused by which of the following?
A) A decrease in government spending.
B) Technological change.
C) A higher exchange rate.
D) A decrease in tax rates.
E) An increase in tax rates.
Answer: D

44) Those who advocate a balanced budget fiscal policy would agree with all but one of the following
statements. Which is the exception?
A) Governments should be non-interventionist.
B) The economy is capable of automatic self-adjustment in response the problems of
unemployment and inflation.
C) Government budget deficits are a serious problem.
D) Counter cyclical fiscal policy is a powerful and effective tool.
E) Automatic stabilizers are an effective way of avoiding extreme levels of unemployment or
inflation.
Answer: D

45) All
of the following, except one, are examples of automatic stabilizers. Which is the exception?
A) Welfare payments which increase when the economy suffers a recession.
B) Progressive income taxes.
C) Employment insurance which decreases when the economy is doing well.
D) Expenditures on education which automatically rise when the number of school-aged children
increases.
Answer: D

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 46) Suppose that the economy is experiencing both an inflationary gap and a budget surplus. Which of
the following is true?
A) Attempts to balance the budget would be counter-cyclical.
B) Reducing the size of the gap would reduce the surplus.
C) Attempts to balance the budget would be pro-cyclical.
D) Attempts to balance the budget would eliminate or reduce the size of the gap.
Answer: C

47) Abalanced-budget philosophy would be pro-cyclical in all the following cases except one. Which
one is the exception?
A) An inflationary gap and a budget deficit. B) A recessionary gap and a budget deficit.
C) An inflationary gap and a budget surplus. D) High unemployment and a budget deficit.
Answer: A

48) Assumethat the economy is in a recession and the government is experiencing a budget deficit.
What happens if balanced-budget fiscal policy is used to eliminate the deficit?
A) GDP will rise.
B) Unemployment will fall.
C) NTR will remain unchanged.
D) Government spending will fall.
E) The deficit could be eliminated if GDP rose.
Answer: D

49) What is the effect of a decrease in both government spending and taxes by the same amount?
A) There will be no effect on GDP or unemployment.
B) GDP will rise and unemployment will fall.
C) GDP will fall but unemployment will rise.
D) Both GDP and unemployment will rise.
E) Both GDP and unemployment will fall.
Answer: C

Below is some data for a hypothetical economy:

50) Refer to the information above to answer this question. What is the value of equilibrium income?
A) $547 B) $1,050 C) $3,150 D) $1,915 E) $175
Answer: B

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 51) Refer to
the information above to answer this question. At equilibrium GDP, what is the value of the
budget surplus/deficit?
A) 20 B) -130 C) 0 D) +20
Answer: C

52) Refer to the information above to answer this question. At equilibrium GDP, what is the value of
Xn?
A) +2 B) -2 C) -5 D) +5
Answer: A

53) Refer to
the information above to answer this question. If government increased both its spending
and taxes by $60, what would be the new equilibrium income?
A) $1,210 B) $823.33 C) $1,090 D) $1,050 E) $1,070
Answer: C

54) Refer tothe information above to answer this question. If government decreased both its spending
and taxes by $45, how would equilibrium GDP change?
A) It would decrease by $30. B) It would increase by $30.
C) It would increase by $60. D) It would decrease by $60.
Answer: A

Below is some data for a hypothetical economy:

55) Refer to the information above to answer this question. What is the value of equilibrium income?
A) $720 B) $675 C) $780 D) $583.33 E) $700
Answer: E

56) Refer tothe information above to answer this question. What is the value of the government's
budget at equilibrium income?
A) In deficit by $20
B) In surplus by $40
C) In deficit by $40
D) In surplus by $20
E) In deficit by $190
Answer: D

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57) Refer tothe information above to answer this question. Suppose the economy is presently in
equilibrium. If the government increases its spending by the amount of its current surplus/deficit,
what will be the result?
A) Increase equilibrium income by $80 and increase the surplus.
B) Increase equilibrium income by $80 and reduce the surplus.
C) Increase equilibrium income by $40 and increase the surplus.
D) Increase equilibrium income by $40 and balance the budget.
E) Increase equilibrium income by $40 and reduce the surplus.
Answer: E

58) Acyclically-balanced budget philosophy involves all, except one, of the following. Which is the
exception?
A) It calls for budget deficits when there is recession and budget surpluses when there is an
inflationary gap.
B) It requires that governments spend more at times and less at other times.
C) It aims to balance the budget over the life of the business cycle.
D) It implies that a government balances its budget in each year.
Answer: D

59) Which of the following is not part of a cyclically-balanced-budget fiscal policy?

A) Budget surpluses in periods of an inflationary gap.
B) A balanced budget over the life of the business cycle.
C) Budget deficits during expansionary phases.
D) Budget deficits in periods of a recessionary gap.
Answer: C

60) Which of the following statements best illustrates a cyclically balanced-budget fiscal policy?
A) A balanced budget is the only appropriate fiscal policy.
B) The budget should be balanced each budget year.
C) The life of the business cycle is the appropriate time period to attempt to balance the budget.
D) The budget should always balance.
E) Fiscal policy really has nothing to do with the budget.
Answer: C

61) Which of the following is a potential problem with a cyclically balanced-budget fiscal policy?
A) Governments find it easier to cut spending in periods of an inflationary gap than raise spending
in periods of a recessionary gap.
B) Governments can raise and lower spending levels at will.
C) Governments never cut taxes.
D) The life of the business cycle is often too short.
E) Governments find it easier to raise spending in periods of a recessionary gap than cut spending
in periods of an inflationary gap.
Answer: E

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Below is some information about the state of the budget and the economy.

1. A budget deficit and a recessionary gap.

2. A budget deficit and an inflationary gap.
3. A budget surplus and a recessionary gap.
4. A budget surplus and an inflationary gap.

62) Refer to
the information above to answer this question. When would a balanced-budget fiscal policy
be pro-cyclical?
A) 2 only. B) 2 and 3. C) 1 and 4. D) 1 only.
Answer: C

63) Refer to the information above to answer this question. When would a counter-cyclical fiscal policy
call for a decrease in government spending or a tax increase?
A) 2 and 4. B) 1 only. C) 2 only. D) 1 and 4.
Answer: A

64) Refer to
the information above to answer this question. When would a balanced-budget fiscal policy
be counter-cyclical?
A) 4 only. B) 3 only. C) 3 and 4. D) 2 and 3.
Answer: D

65) What will be the effect on the multiplier of a decrease in autonomous taxes?
A) There will be no effect on the multiplier.
B) It will increase.
C) It will decrease.
D) Cannot be determined without more information.
Answer: A

66) In 2013, in Canada, what percentage of the national debt was owned by foreigners?
A) 29% B) 5% C) None D) 50% E) 16%
Answer: A

67) In 2013, in Canada, what was the size of the national debt?
A) $350.8 billion B) $873.6 billion C) $200.6 billion D) $544.2 billion
Answer: D

68) Since the end of World War II, what has happened to the public debt?
A) It has grown absolutely but has recently declined in terms of real per capita debt.
B) It has grown absolutely and in terms of real per capita debt.
C) It has remained constant absolutely, but has declined as a percentage of the GDP.
D) It has declined absolutely, but has remained constant as a percentage of the GDP.
E) It has grown absolutely but has remained constant in terms of real per capita debt.
Answer: A

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69) What is true about the national debt since the early 1990s?
A) It has grown absolutely, but has declined as a percentage of GDP.
B) It has declined absolutely, but has grown as a percentage of GDP.
C) It has grown both absolutely and as a percentage of GDP.
D) It has declined both absolutely and as a percentage of GDP.
E) It has grown absolutely, but has remained constant as a percentage of GDP.
Answer: A

70) All
of the following, except one, are reasons why Canada's national debt has grown. Which is the
exception?
A) Building necessary infrastructure such as roads and bridges and the address a recessionary gap.
B) World War II.
C) Increased expenditures on income-support programs.
D) Consistently falling tax revenue.
Answer: D

71) All
of the following, except one, are correct statements. Which is the exception?
A) The foreign portion of the public debt has been eliminated over the past decade.
B) The public debt refers to the debts of all units of government: federal, provincial and local.
C) The public debt is the accumulation of all the federal government's deficits and surpluses of the
past.
D) Provincial and municipal governments in total have realized budget surpluses in some years.
Answer: B

72) What isthe meaning of the phrase: "the national debt is also a national credit"?
A) Only interest payments on the national debt constitute an economic burden.
B) Official figures seriously understate the size of the national debt.
C) What is owed must equal what is owned.
D) The national debt is a government debt held by the Bank of Canada and both of these are
public institutions.
E) The national debt is equal to the physical assets owned by the government.
Answer: C

73) What was the national debt/GDP ratio in Canada in 2013?

A) 20% B) 10% C) 33% D) 100%
Answer: C

74) Which of the following statements is an accurate comment on the payment of interest on the public
debt?
A) It has no effect on the distribution of income.
B) It leads to an increase in our standard of living.
C) It probably increases income inequality.
D) It decreases the value of a country's assets.
E) It probably decreases income inequality.
Answer: C

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75) How may the public debt impose a burden upon future generations?
A) By causing a slowly falling price level.
B) By causing future unemployment.
C) By reducing the current level of private capital accumulation.
D) By causing interest rates to be lower than otherwise.
Answer: C

76) Which of the following is a true statement in reference to the national debt?
A) As a percentage of GDP, it has steadily grown since World War II.
B) It is almost entirely a result of World War II.
C) As a percentage of GDP, it has decreased in recent years.
D) It is now growing at about $10 billion per year.
E) It is now large enough for one to question the government's solvency.
Answer: C

77) Which of the following is a legitimate concern over the national debt?
A) Some future generation will have to pay it off.
B) The costs of servicing the debt each year comes out of current tax revenues.
C) It represents a failure of Keynesian economic policy.
D) It is no longer held externally.
Answer: B

78) What is fiscal policy?

A) It is the government's policy on taxation.
B) It is the central bank's policy on interest rates.
C) It is the government's policy on both spending and taxation.
D) It is the government's policy on spending.
Answer: C

79) Which of the following would close an inflationary gap?

A) A decrease in government spending. B) An increase in government spending.
C) A decrease in taxes. D) An increase in exports.
Answer: A

80) Towhat group is the largest portion of the national debt owed?
A) The Government of Canada.
B) Foreign individuals, banks, and businesses.
C) The Bank of Canada.
D) The Canadian public, that is, individuals, businesses, and banks in Canada.
Answer: D

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81) What is net tax revenue?
A) It is the total of all taxes collected by government less spending by government on goods and
services.
B) It is the total of all taxes collected by the government.
C) It is the total of all taxes collected by government plus transfer payments.
D) It is the total of all taxes collected by government less transfer payments.
Answer: D

82) When does agovernment budget surplus exist?

A) When net tax revenue exceeds government spending on goods and services.
B) When net tax revenue exceeds government spending of all types.
C) When government spending of all types exceeds net tax revenue.
D) When government spending on goods and services exceeds net tax revenue.
Answer: A

83) What is true about the national debt since the 1960s until the 1990s?
A) It grew both absolutely and as a percentage of GDP.
B) It grew absolutely but has declined as a percentage of a GDP.
C) It declined absolutely, but increased as a percentage of GDP.
D) It grew absolutely but remained constant as a percentage of GDP.
Answer: A

84) What is the effect of a counter-cyclical fiscal policy?

A) It intensifies changes in GDP caused by the business cycle.
B) It allows the government to balance its budget.
C) It dampens changes in GDP caused by the business cycle.
D) It has no effect on changes in GDP caused by the business cycle.
Answer: C

85) What would cause the aggregate demand curve to shift to the right?
A) An increase in taxes.
B) Counter-cyclical fiscal policy used to eliminate recessionary gap.
C) An increase in net tax revenues.
D) A decrease in government spending on goods and services.
Answer: B

86) What can cause an upward (left) shift in the budget line?
A) An increase in taxes. B) An increase in government spending.
C) A decrease in taxes. D) An increase in GDP.
Answer: A

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87) Which of the following statements about counter-cyclical fiscal policy is correct?
A) It involves only higher government spending.
B) It is appropriate in situations of a recessionary gap but not when an inflationary gap exists.
C) It involves only higher taxes.
D) It is appropriate in situations of an inflationary gap but not when a recessionary gap exists.
E) It is the use of spending or taxation policies by the government to push the economy in a
direction opposite to the way it was moving.
Answer: E

88) What are automatic stabilizers?

A) Tax provisions and government spending programmes that automatically put money into the
economy in a recessionary period and take it out in a boom period.
B) Consumption spending which automatically changes with the state of the economy so as to
stabilize the economy.
C) Investment spending which automatically changes with the state of the economy so as to
stabilize the economy.
D) Imports and exports that automatically change with the state of the economy so as to stabilize
the economy.
Answer: A

89) What isa cyclically balanced-budget fiscal policy?

A) A policy of balancing the budget over the life of the business cycle.
B) A policy of using the budget to balance the economy over the life of the business cycle.
C) A policy of using the budget to balance the economy each fiscal year.
D) A policy of balancing the budget each fiscal year.
Answer: A

19
90) Refer tothe figure above to answer this question. Which of the following statements is verified by the graph?
Refer To: 07-94
A) NTR is a function of the level of government spending.
B) If government spending was reduced from G 1 to G2 , the budget surplus at Y2 would decrease.
C) A budget deficit exists if government spending is G1 and real GDP is Y1 .
D) A budget surplus exists if government spending is G 1 and real GDP is Y1 .
Answer: C

91) Refer tothe figure above to answer this question. What is most likely to happen if the level of GDP
is Y1 and the government reduces its spending from G 1 to G2 in an attempt to balance its budget?
A) GDP would be Y 2 , and the budget would be in surplus.
B) GDP would be Y 2 , and the budget would be in deficit.
C) GDP would remain at Y1 , but the budget would be in deficit.
D) The budget would be balanced at the new GDP level Y 2 .
Answer: B

20
92) Refer tothe figure above to answer this question. If government spending is G 1 and GDP is Y1 , why
won't a reduction in government spending by the size of the budget deficit eliminate the deficit?
A) Because government spending is a function of income.
B) Because NTR will rise as a result of the decrease in government spending.
C) Because GDP will rise as a result of the decrease in government spending.
D) Because GDP and NTR will decrease as a result of the decrease in government spending.
Answer: D

93) Which of the following statements concerning a budget deficit is true?

A) It can be measured in terms of the amount of unemployment that it causes.
B) It is smaller if the economy is experiencing strong aggregate demand.
C) It is smaller if the economy is in the midst of a severe recession.
D) It reduces the size of the national debt.
Answer: B

94) Which of the following is true if the government attempts to balance its budget when the economy is
in a recession and the government is running a budget deficit?
A) Inflation would result.
B) The unemployment rate would decrease.
C) The action would be pro-cyclical.
D) GDP would increase.
E) Government spending would have to increase.
Answer: C

95) What is the effect of counter-cyclical fiscal policy on the price level?
A) It will decrease in the case of a recessionary gap.
B) It will have no effect in the case of a recessionary gap.
C) It will increase in the case of a recessionary gap.
D) It will have no effect in the case of an inflationary gap.
E) It will increase in the case of an inflationary gap.
Answer: C

21
 96) All of the following, except one, are arguments against the use of counter-cyclical fiscal policy to
close a recessionary gap. Which is the exception?
A) Counter-cyclical fiscal policy can reduce budget deficits, but this would also lower the
exchange rate.
B) Counter-cyclical fiscal policy can be inflationary.
C) Counter-cyclical fiscal policy is subject to serious time lags.
D) Counter-cyclical fiscal policy can increase interest rates and crowd out private investment
spending.
Answer: A

97) What is the result of using balanced-budget fiscal policy when both a recessionary gap and a budget
deficit exist?
A) The recessionary gap would increase and the budget deficit would rise.
B) The recessionary gap would be reduced and the budget deficit would fall.
C) The recessionary gap would increase and the budget deficit would fall.
D) The recessionary gap would be reduced and the budget deficit would rise.
Answer: C

98) Suppose that counter-cyclical fiscal policy pushed up interest rates and the economy had a flexible
exchange rate. Which of the following would be true?
A) The exchange rate would fall, and exports would fall.
B) The exchange rate would rise, and exports would fall.
C) The exchange rate would fall, and exports would rise.
D) The exchange rate would rise, and exports would rise.
Answer: B

99) Suppose that an economy is simultaneously experiencing a budget deficit and an inflationary gap. If
the government attempts to balance the budget, what will be the effect?
A) Real GDP will increase, and the deficit will increase.
B) Real GDP will decrease, and the deficit will increase.
C) Real GDP will decrease, and the deficit will decrease.
D) Real GDP will increase, and the deficit will decrease.
Answer: C

100) Which of the following is not an automatic stabilizer?

A) Personal income tax. B) Transfers to persons.
C) Public debt charges. D) E.I premiums.
Answer: C

22
101) Which is the largest source of government revenue?
A) Personal income taxes.
B) Corporate income taxes.
C) Lottery revenues.
D) E.I. premiums
E) GST and excise taxes.
Answer: A

102) Which of the following is a stock concept?

A) The deficit. B) Government tax revenue.
C) Direct program spending. D) Public debt.
Answer: D

103) Which of the following is one of the reasons why the Canadian government went from budget
deficits to budget surpluses in the late 1990s?
A) Higher corporate tax rates.
B) Elimination of the national debt has eliminated interest payments.
C) Declining GDP.
D) Decreased transfer payments to the provinces for health and education.
E) Increased program spending.
Answer: D

104) Some economists believe that the economy returns to full-employment equilibrium through a
self-adjustment process. Which type of fiscal policy would they support?
A) Balanced-budget
B) Counter-cyclically balanced budget.
C) Interventionist.
D) Counter-cyclical.
E) Cyclically balanced budget.
Answer: A

105) Can a counter-cyclical fiscal policy ever result in a balanced budget?

A) Never. The goal of counter-cyclical fiscal policy is annual deficits.
B) Yes, unless the economy is experiencing a recessionary gap.
C) Yes, if the economy is experiencing a recessionary gap.
D) Yes, if the economy is experiencing an inflationary gap with a budget deficit.
E) Yes, if the economy is experiencing a recessionary gap with a budget deficit.
Answer: D

106) What is an appropriate reason for the government to borrow money?

A) To inject new spending into the economy.
B) To discourage waste in fiscal affairs.
C) To encourage foreign ownership of the debt.
D) To compensate for a lower bond rating.
Answer: A

23
107) What is the redistribution effect of a high domestic-owned national debt?
A) Income is redistributed from lenders to borrowers.
B) Income is redistributed from bondholders to taxpayers.
C) Income is redistributed from taxpayers to bondholders.
D) Income is redistributed from lenders to governments.
E) There is no redistribution effect of domestic debt.
Answer: C

108) Assume the economy is experiencing an inflationary gap and the government has a budget surplus.
Which of the following is a correct example of counter-cyclical fiscal policy with the corresponding
effect on the budget?
A) Government spending increases causing a smaller budget surplus.
B) Government spending decreases causing a larger budget surplus.
C) Tax rates decrease causing a smaller budget surplus.
D) Transfer payments and tax rates both decrease.
E) Government spending increases causing a larger budget surplus.
Answer: B

109) Suppose an economy is in a recession and the government is experiencing a budget deficit.
What will be a possible effect of the government's decision to borrow money in order to increase spending and
real GDP?"
A) There will be no effect of government borrowing on investment spending or real GDP.
B) The government borrowing will increase the demand for money, causing interest rates to rise
and investment spending to be crowded out.
C) The government borrowing will increase the demand for money causing interest rates to rise
and investment spending to increase.
D) The government borrowing will increase the supply of money, causing interest rates to fall and
investment spending to be crowded out.
Answer: B

110) Suppose an economy is currently operating at Potential Real GDP and government expenditure is
greater than net tax revenue. In this case, the government has a:
A) cyclically balanced budget. B) cyclical deficit budget balance.
C) structurally balanced budget. D) structural deficit budget balance.
Answer: D

111) Suppose an economy is operating below Potential Real GDP and the government has a structural
deficit equal to $100 billion. If the total government deficit is equal to $150 billion then the cyclical
deficit is equal to:
A) $100 billion. B) $250 billion. C) $150 billion. D) $50 billion.
Answer: D

24
 112) Suppose an economy is operating above Potential Real GDP and the government has a structural
surplus equal to $150 billion. If the total government surplus is equal to $170 billion then the
cyclical surplus is equal to:
A) $20 billion. B) $150 billion. C) $320 billion. D) $170 billion.
Answer: A

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

113) The national debt is the sum of the federal government's past budget deficits less its surpluses.
Answer: True False

114) If aggregate demand increases as a result of counter-cyclical fiscal policy, prices will rise and GDP
will fall.
Answer: True False

115) Counter-cyclical fiscal policy aimed at closing an inflationary gap is illustrated graphically by the
aggregate demand curve shifting to the left.
Answer: True False

116) Both net tax revenues and government spending on goods and services are a function of GDP.
Answer: True False

117) A decrease in government spending on goods and services will shift the budget line up.
Answer: True False

118) A decrease in autonomous taxes would pivot the NTR line down.
Answer: True False

119) Counter-cyclical fiscal policy is aimed at balancing the budget, whereas a balanced-budget fiscal
policy is aimed at balancing the economy.
Answer: True False

120) If government spending on goods and services is increased by exactly the same amount that taxes
are increased, the level of GDP will not change.
Answer: True False

121) In trying to cure a recession, counter-cyclical fiscal policy may crowd out both private investment
and export spending.
Answer: True False

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.

122) To whom does the federal government owe most of its debt?
Answer: The federal government owes most of its debt to Canadians-to banks, insurance companies,
and other firms, institutions or individuals who buy Canadian government bonds. Only 14
percent (in 2004) was foreign-owned.

25
123) What is the primary goal of counter-cyclical fiscal policy? What are three criticisms of it?
Answer: The primary goal of counter-cyclical fiscal policy is to correct problems in the economy. It does this by
increasing spending (or decreasing taxes) when the economy is in a recession and by decreasing
spending (or increasing taxes) when the economy is in an inflationary boom. Three criticisms of this
policy are:
• it is subject to serious time lags
• it is ineffective because it may be inflationary, and may crowd out private spending
• it can lead to serious budget deficits.

124) What is the primary goal of a balanced budget fiscal policy? What is the major criticism of it?
Answer: The primary goal of a balanced-budget fiscal policy is to ensure that the government's budget
is balanced on an annual basis. The major criticism of this policy is that it may be pro-cyclical
and if the economy is heading to a recession, could make the recession worse; if heading to an
inflationary boom, could make the boom bigger. In other words, by concentrating solely on
balancing the budget, it ignores the problems of the economy, and at times, may even
exacerbate them.

125) What is meant by cyclically balanced budget fiscal policy?

Answer: A cyclically-balanced budget fiscal policy is one which attempts to balance the government's
budget not on an annual basis, but over the period of the business cycle.

126) What are automatic stabilizers? How do they work?

Answer: An automatic stabilizer is any government program or policy that will counteract the business
cycle without any new government action. To see how they work, consider the example of
unemployment insurance. When people lose their jobs they will decrease their spending (since
they have no income they reduce expenses) and this can lead to a multiplied decline in
aggregate income. Unemployment insurance provides some income for those newly
unemployed so that their consumption doesn't drop by as much and thus the aggregate income
doesn't drop by as much.

127) Define the terms deficit and debt. Which is a flow concept and which is a stock concept?
Answer: A deficit is a shortfall of revenues under expenditures. A deficit occurs when spending
exceeds revenues. Debt is accumulated deficits minus accumulated surpluses. The deficit is a
flow concept, while debt is a stock concept.

128) Why do economists prefer to examine the debt as a percentage of GDP rather than the level of debt?
Answer: The best measure of the size of the debt is relative to the ability to repay, and this is relative to
income.

129) What has been happening to the Canadian National debt since WW II? To the debt/GDP ratio?
Answer: The debt has been increasing until recent years but the debt/GDP ratio has varied) specifically,
the debt/GDP ratio decreased during the 1950s and 1960s; increased in the 1970s and 1980s;
has been decreasing since the early 1990s.

26
130) Answer the questions below for the economy of Makala, using the following graph:

a) If GDP in Makala is $300, what is the government's budget balance?

b) If government spending is increased by the size of the deficit, and the multiplier is 2.5, what is the new level
of equilibrium GDP?
c) What is the size of the government's deficit at this new level of equilibrium GDP?
Answer: a) Deficit of $40
b) $400
c) Deficit of $40

27
131) Given the following data for the economy of Mokka:

a) Calculate equilibrium GDP.

b) Calculate the multiplier.
c) If the tax function is: T = 30 + 0.2Y, calculate the government's budget balance.
d) Now change government spending by the amount of the surplus or deficit in an attempt to balance the
budget. What will be the new equilibrium GDP?
e) What is the budget balance at the new equilibrium?
Answer: a) $1025
b) 2.5
c) Budget surplus of $20.
d) $1,075
e) Budget surplus of $10.

132) Assume that in the economy of Utrea, the MPC is 0.8 and the multiplier is 3 and that both
government spending and autonomous taxes are increased by $40. In what direction and by how
much will equilibrium GDP change?
Answer: GDP will increase by $24.

133) Assume that the economy is at full employment.

a) Explain the effect to the economy if there is an increase in foreign income.
b) Explain how countercyclical fiscal policy will adjust the economy back to full employment.
Answer: a) An increase in foreign income will increase the demand for domestic exports. The increase in export
expenditure will increase aggregate demand, and thus, the level of real GDP and price level will
increase, which will result in an inflationary gap.
b) Countercyclical fiscal policy will call for an increase in taxation and/or a decrease in government
spending. The increase in taxation reduces disposable income which will lower consumption
spending. Lower consumption and/or government spending will decrease aggregate demand.
The level of real GDP and price level will fall and the inflationary gap will be eliminated.

134) Assume that the economy is at full employment.

a) Explain the effect to the economy if there is a decrease in investment spending.
b) Explain how countercyclical fiscal policy will adjust the economy back to full employment.
Answer: a) A decrease in investment spending will decrease aggregate demand. The level of real GDP and the
price level will fall, which will result in a recessionary gap.
b) Countercyclical fiscal policy will call for a decrease in taxation and/or increase in government
spending. The decrease in taxation increases disposable income which will increase consumer
spending. Higher consumption and/or government spending will increase aggregate demand.
The level of real GDP and price level will rise and the recessionary gap will be eliminated.

28
135) List the 5 potential problems associated with the national debt.
Answer: • Crowding-out of private investment and net exports
• Interest payments that must be paid out on its foreign-held portion
• Income distribution effects of large interest payments
• Reduce ability of government to meet the needs of its citizen
• Possible increased greed and wastefulness of government

136) What effect will an expansionary fiscal policy have on interest rates and the exchange rate?
Answer: An expansionary fiscal policy implies an increase in aggregate demand. An increase in
aggregate demand will increase the price level and real GDP. An increase in nominal GDP
will increase the demand for money, thus interest rates will rise. An increase in the interest
rate will increase foreign portfolio investment. The increase demand for domestic currency (by
foreigners) will appreciate the domestic currency; exchange rates will be higher.

137) What are the three schools of thought on fiscal policy?

Answer: One school of thought, countercyclical fiscal policy, believes government needs to intervene
directly to achieve the goals of full employment and stable prices. Another group,
balanced-budget fiscal policy, believes government should not intervene. The third, cyclically
balanced budget fiscal policy is a compromise between the two opposing schools of thought
which advocates that budgets should be balanced but over a longer period of time, the
business cycle.

138) Distinguish between a government's internal and external debt.

Answer: The domestic portion of the Government debt (the amount owed to Canadians) is internal
debt and the foreign portion of the debt is external debt.

139) "The level of real GDP does not change when the government decreases government spending and
taxes by the same amount." Evaluate this statement.
Answer: This statement is incorrect. A policy of decreasing both government spending and taxes by the
same amount will lower the level of real GDP because consumers do not spend all of the
additional disposable income. For each additional dollar of income, consumers spend a
portion and save the remainder.

140) What are the problems associated with a cyclically balanced budget fiscal policy?
Answer: There are three problems with a cyclically balanced budget fiscal policy. First, there is no
guarantee that the budget will be balanced over the life of the business cycle. Second, most
governments find it easier to increase spending in bad times than to decrease it in good times.
Third, the political cycle (term of office) is usually shorter than the length of the business
cycle which might mean that no ruling government will take responsibility for the budget.

29
141) Suppose the government's budget is balanced. What is the consequence to the level of national debt
if expansionary fiscal policy is used to eliminate a recessionary gap?
Answer: To eliminate a recessionary gap with expansionary fiscal policy implies that the government
will increase government spending and/or decrease taxation. This will lead a budget deficit
resulting in an increase in the level of national debt.

142) What are the major expenses for the Government of Canada?
Answer: The major outlays for the Government of Canada can be classified into four groups. Direct
program spending is part of government spending on goods are services. Transfer to persons
includes payments toward Old Age Security and CPP payments. Public debt charges are
interest payments. The last item, spending grants to other levels of government, are payments
to the provinces and cities.

143) Explain how the Government of Canada finances its budget deficits.
Answer: Budget deficits are financed by borrowing. The Canadian government may borrow by selling
government bonds to the public and/or the Bank of Canada.

144) Explain how counter-cyclical fiscal policy might lead to serious budget deficits.
Answer: Suppose the economy is experiencing a recessionary gap (Y E < YFE) and a budget deficit (T < G)
at the same time) If the government employs counter-cyclical fiscal policy to eliminate the output gap,
will increase government spending (↑G) or lower taxes (↓T). This policy will increase the size of the
budget deficit.

145) Suppose the government is expecting a budget surplus. List three things governments can do to
reduce or eliminate the expected budget surplus.
Answer: The government can:
• increase government spending;
• reduce taxation;
• reduce the level of national debt.

30
146) Given the following parameters for the economy of Pitris:

a) What is the value of expenditures equilibrium?

b) Does the government have a budget surplus or a budget deficit at expenditures equilibrium? What is the
value of the budget surplus or deficit?
c) What is the value of the multiplier?
Answer: a) $1,840
b) Government deficit of $55
c) 4

147) Given the following parameters for the economy of New Temple:

Suppose the government is required by law to maintain a balanced budget.

a) What is the value of equilibrium income?

b) What is the value of G at equilibrium income?
c) What is the value of the multiplier?
Answer: a) $1,400
b) $320
c) 4

31
148) Given the following parameters for the economy of North Happin:

a) What is the value of equilibrium income?

b) What is the value of the government budget at equilibrium income? Suppose $4,000 is the full employment
level of income for North Happin.
c) By how much should the government of North Happin change G to reach full employment? Cannot
calculate with the new consumption function
Answer: a) $3,750
b) Budget surplus of $27.50
c) Increase G by $100

32
149) Suppose the government Daikai balances its budget over a five year period. Autonomous taxes are $50 and the
marginal tax rate is 25%. The following table shows the level of GDP and government expenditure in each of
the first 5 years:

a) Fill in column (4) and (5). Suppose the level of GDP for Year 5 is $380 million.
b) What level of government spending in Year 5 will balance the budget over the five-year cycle?
c) What level of autonomous taxes in Year 5 will balance the budget over the five-year cycle?
Answer: a)

a) to calculate (4) T = 25% of GDP + $50 autonomous taxes. (e.g. (1) 25% of 300 = 75 + 50 = 125)
b) $155 million
c) $25 million

150) Suppose MTR = 0.3 and G = $300 million for the economy of White Forest.

a) At what level of GDP will White Forest have a balanced budget?

b) At what level of GDP will White Forest have a budget surplus of $60 million?
c) What is the balance of the government budget if the level of GDP is $900 million?
Answer: a) $1,000 million
b) $1,200 million
c) Deficit of $30 million

33
Answer Key
Testname: UNTITLED6

1) B
2) E
3) C
4) C
5) C
6) B
7) D
8) D
9) B
10) A
11) C
12) C
13) A
14) B
15) A
16) A
17) E
18) A
19) B
20) A
21) E
22) A
23) D
24) B
25) C
26) E
27) C
28) D
29) C
30) E
31) B
32) D
33) B
34) B
35) D
36) C
37) A
38) B
39) A
40) D
41) D
42) E
43) D
44) D
45) D
46) C
47) A
48) D
49) C
50) B
34
Answer Key
Testname: UNTITLED6

51) C
52) A
53) C
54) A
55) E
56) D
57) E
58) D
59) C
60) C
61) E
62) C
63) A
64) D
65) A
66) A
67) D
68) A
69) A
70) D
71) B
72) C
73) C
74) C
75) C
76) C
77) B
78) C
79) A
80) D
81) D
82) A
83) A
84) C
85) B
86) A
87) E
88) A
89) A
90) C
91) B
92) D
93) B
94) C
95) C
96) A
97) C
98) B
99) C
100) C
35
Answer Key
Testname: UNTITLED6

101) A
102) D
103) D
104) A
105) D
106) A
107) C
108) B
109) B
110) D
111) D
112) A
113) TRUE
114) FALSE
115) TRUE
116) FALSE
117) TRUE
118) FALSE
119) FALSE
120) FALSE
121) TRUE
122) The federal government owes most of its debt to Canadians-to banks, insurance companies, and other
firms, institutions or individuals who buy Canadian government bonds. Only 14 percent (in 2004) was
foreign-owned.
123) The primary goal of counter-cyclical fiscal policy is to correct problems in the economy. It does this by increasing
spending (or decreasing taxes) when the economy is in a recession and by decreasing spending (or increasing taxes)
when the economy is in an inflationary boom. Three criticisms of this policy are:
• it is subject to serious time lags
• it is ineffective because it may be inflationary, and may crowd out private spending
• it can lead to serious budget deficits.
124) The primary goal of a balanced-budget fiscal policy is to ensure that the government's budget is balanced
on an annual basis. The major criticism of this policy is that it may be pro-cyclical and if the economy is
heading to a recession, could make the recession worse; if heading to an inflationary boom, could make
the boom bigger. In other words, by concentrating solely on balancing the budget, it ignores the problems
of the economy, and at times, may even exacerbate them.
125) A cyclically-balanced budget fiscal policy is one which attempts to balance the government's budget not
on an annual basis, but over the period of the business cycle.
126) An automatic stabilizer is any government program or policy that will counteract the business cycle
without any new government action. To see how they work, consider the example of unemployment
insurance. When people lose their jobs they will decrease their spending (since they have no income they
reduce expenses) and this can lead to a multiplied decline in aggregate income. Unemployment insurance
provides some income for those newly unemployed so that their consumption doesn't drop by as much and
thus the aggregate income doesn't drop by as much.

36
Answer Key
Testname: UNTITLED6

127) A deficit is a shortfall of revenues under expenditures. A deficit occurs when spending exceeds revenues.
Debt is accumulated deficits minus accumulated surpluses. The deficit is a flow concept, while debt is a
stock concept.
128) The best measure of the size of the debt is relative to the ability to repay, and this is relative to income.
129) The debt has been increasing until recent years but the debt/GDP ratio has varied) specifically, the
debt/GDP ratio decreased during the 1950s and 1960s; increased in the 1970s and 1980s; has been
decreasing since the early 1990s.
130) a) Deficit of $40
b) $400
c) Deficit of $40
131) a) $1025
b) 2.5
c) Budget surplus of $20.
d) $1,075
e) Budget surplus of $10.
132) GDP will increase by $24.
133) a) An increase in foreign income will increase the demand for domestic exports. The increase in export expenditure
will increase aggregate demand, and thus, the level of real GDP and price level will increase, which will result in an
inflationary gap.
b) Countercyclical fiscal policy will call for an increase in taxation and/or a decrease in government spending. The
increase in taxation reduces disposable income which will lower consumption spending. Lower
consumption and/or government spending will decrease aggregate demand. The level of real GDP and
price level will fall and the inflationary gap will be eliminated.
134) a) A decrease in investment spending will decrease aggregate demand. The level of real GDP and the price level wi
fall, which will result in a recessionary gap.
b) Countercyclical fiscal policy will call for a decrease in taxation and/or increase in government spending. The
decrease in taxation increases disposable income which will increase consumer spending. Higher consumption
and/or government spending will increase aggregate demand. The level of real GDP and price level will
rise and the recessionary gap will be eliminated.
135) • Crowding-out of private investment and net exports
• Interest payments that must be paid out on its foreign-held portion
• Income distribution effects of large interest payments
• Reduce ability of government to meet the needs of its citizen
• Possible increased greed and wastefulness of government
136) An expansionary fiscal policy implies an increase in aggregate demand. An increase in aggregate demand
will increase the price level and real GDP. An increase in nominal GDP will increase the demand for
money, thus interest rates will rise. An increase in the interest rate will increase foreign portfolio
investment. The increase demand for domestic currency (by foreigners) will appreciate the domestic
currency; exchange rates will be higher.

37
Answer Key
Testname: UNTITLED6

137) One school of thought, countercyclical fiscal policy, believes government needs to intervene directly to
achieve the goals of full employment and stable prices. Another group, balanced-budget fiscal policy,
believes government should not intervene. The third, cyclically balanced budget fiscal policy is a
compromise between the two opposing schools of thought which advocates that budgets should be
balanced but over a longer period of time, the business cycle.
138) The domestic portion of the Government debt (the amount owed to Canadians) is internal debt and the
foreign portion of the debt is external debt.
139) This statement is incorrect. A policy of decreasing both government spending and taxes by the same
amount will lower the level of real GDP because consumers do not spend all of the additional disposable
income. For each additional dollar of income, consumers spend a portion and save the remainder.
140) There are three problems with a cyclically balanced budget fiscal policy. First, there is no guarantee that
the budget will be balanced over the life of the business cycle. Second, most governments find it easier to
increase spending in bad times than to decrease it in good times. Third, the political cycle (term of office)
is usually shorter than the length of the business cycle which might mean that no ruling government will
take responsibility for the budget.
141) To eliminate a recessionary gap with expansionary fiscal policy implies that the government will increase
government spending and/or decrease taxation. This will lead a budget deficit resulting in an increase in
the level of national debt.
142) The major outlays for the Government of Canada can be classified into four groups. Direct program
spending is part of government spending on goods are services. Transfer to persons includes payments
toward Old Age Security and CPP payments. Public debt charges are interest payments. The last item,
spending grants to other levels of government, are payments to the provinces and cities.
143) Budget deficits are financed by borrowing. The Canadian government may borrow by selling government
bonds to the public and/or the Bank of Canada.
144) Suppose the economy is experiencing a recessionary gap (Y E < YFE) and a budget deficit (T < G) at the same
time) If the government employs counter-cyclical fiscal policy to eliminate the output gap, it will increase
government spending (↑G) or lower taxes (↓T). This policy will increase the size of the budget deficit.
145) The government can:
• increase government spending;
• reduce taxation;
• reduce the level of national debt.
146) a) $1,840
b) Government deficit of $55
c) 4
147) a) $1,400
b) $320
c) 4
148) a) $3,750
b) Budget surplus of $27.50
c) Increase G by $100

38
Answer Key
Testname: UNTITLED6

149) a)

a) to calculate (4) T = 25% of GDP + $50 autonomous taxes. (e.g. (1) 25% of 300 = 75 + 50 = 125)
b) $155 million
c) $25 million
150) a) $1,000 million
b) $1,200 million
c) Deficit of $30 million

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