Topic: FISCAL POLICY. GOVERNMENT EXPENDITURES

AND PUBLIC DEBT

I. Write the definitions:

State budget;

Budget deficit;

Structural budget deficit;

Cyclical budget deficit;

Public debt;

Fiscal policy;

Tax multiplier;

Government purchases multiplier

Transfer multiplier.

II. True / false questions:

1. State budget is the financial plan of public revenues and public expenditures.

2. When the government budget deficit rises, national saving reduced, interest rates rise, and

investment falls.

3. Equal increases in government expenditures and tax collections will leave the equilibrium

GDP unchanged.

4. Inflation can be restrained by increasing government purchases and reducing taxes.

5. The actual budget may be in deficit while the full-employment budget is in surplus.

6. Tax revenues automatically increase during economic expansions and decrease during

recessions.

7. Fiscal policy will generate some inflation if aggregate demand increases in the Keynesian

range of aggregate supply.

8. The public debt is the accumulation of all deficits and surpluses which have occurred

through time.

9. Unemployment insurance and welfare programs work as automatic stabilizers.

10. The government purchases multiplier is computed as MPC / (1 – MPC).

III. Multiple choice questions

1. A budget deficit occurs when:

a) the government spends more than it collects in revenues;

b) the government collects more in revenues than it spends;

c) the National Bank lends more than it borrows;

d) the National Bank borrows more than it lends.

2. The Laffer curve suggests that under certain conditions:

a) a decrease in tax rate may lead to a decrease in tax revenues;

b) an increase in tax rate may lead to an increase in tax revenues;

c) an increase in tax rate may lead to an increase in income;

d) a decrease in tax rate may lead to an increase in tax revenues.

3. A tax which takes a larger proportion of income from low-income groups of people than

from high-income groups is a:

a) progressive tax;

b) proportional tax;

c) regressive tax;

d) stabilizing tax.

4. Economists refer to a budget deficit which exists when the economy achieves the full

employment as:

a) cyclical deficit;

b) natural deficit;

c) actual deficit;

d) structural deficit.

5. Budget surplus is created if

a) the government sells more bonds than it buys back;

b) the government spends more than it receives in tax revenue;

c) private saving is greater than zero;

d) none of the above is correct.

6. The financing of government deficit leads to an increase in the interest rate and, as a

result, reduces investment spending of businesses. This statement describes:

a) the supply-side effects of fiscal policy;

b) built in stability;

c) the crowding-out effect;

d) the net export effect.

7. The greatest expansionary impact of a budget deficit will occur when the:

a) government finances the deficit by obtaining newly printed money;

b) government borrows the money from the general public;

c) economy is operating in the intermediate range of its aggregate supply curve;

d) MPS for the economy is high.

8. Fiscal policy affects the economy:

a) only in the short-run;

b) only in the long-run;

c) in both the short and long-run;

d) in neither the short nor long-run.

9. Fiscal policy refers to the idea that aggregate demand is changed by changes in:

a) the money supply;

b) government spending and taxes;

c) trade policy;

d) all of the above are correct.

10. An increase in government spending initially and primarily shifts:

a) aggregate demand right;

b) aggregate demand left;

c) aggregate supply right.

d) neither aggregate demand nor aggregate supply.

11. The government buys a bridge. The owner of the company that builds the bridge pays

her workers. The workers increase their spending. Firms that the workers buy goods

from increase their output. This type of effect on spending illustrates:

a) the multiplier effect;

b) the crowding-out effect;

c) the Fisher effect;

d) none of the above is correct.

12. Tax cuts:

a) and increases in government expenditures shift aggregate demand right;

b) and increases in government expenditures shift aggregate demand left;

c) shift aggregate demand right while increases in government expenditures shift

aggregate demand left;

d) shift aggregate demand left while increases in government expenditures shift aggregate

demand right.

13. Which of the following is not an automatic stabilizer?

a) the minimum wage;

b) the unemployment compensation system;

c) the federal income tax;

d) the welfare system;

14. Other things the same, automatic stabilizers tend to:

a) raise expenditures during expansions and recessions.

b) lower expenditures during expansions and recessions.

c) raise expenditures during recessions and lower expenditures during expansions.

d) raise expenditures during expansions and lower expenditures during recessions.

15. During expansions, automatic stabilizers make government expenditures:

a) and taxes fall;

b) and taxes rise;

c) rise, and taxes fall;

d) fall and taxes rise.

IV. Problems

1. The Problem. In a closed economy the marginal propensity to consume (MPC) is 0.9,

collected taxes equal $50 bln, government purchases of goods and services are $40 bln.:

a) the government cuts its purchases of goods and services to $30 bln. What is the change in

equilibrium expenditures? What is the value of government purchases multiplier?

b) the government continues to purchase $40 bln., and cuts personal taxes to $30 bln. What is

the change in equilibrium expenditures? What is the value of the personal tax multiplier?

2. The Problem. The government simultaneously raises its purchases by $200 and cuts taxes by

$300. What is the change in equilibrium income if marginal propensity to consume (MPC)

equals 0.9?

3. The Problem. Suppose that in an economy the potential GDP equals to 2000 m.u., and actual

real GDP is 1400 m.u. Government purchases equal 400 m.u., and the tax rate(t) on personal

income is 25 percent. Determine the structural, cyclical and actual budget deficit.

4. The Problem. Suppose that the economy is characterized by the following behavioral

equations:

C = 1000 + 0.9Yd; G = 600 m.u.; I = 390 m.u.; T = 400 m.u.

Determine:a) the value of equilibrium incomeb) the government purchases multiplierc) changes in equilibrium expenditures if the government increases purchases of goods and

services by 200 m.u.

5. The Problem. Suppose that in the economy the aggregate income (GDP) equals 950 m.u.,

consumption expenditures represent 60 percent from aggregate income. Gross private

domestic investment is 230 m.u. Net export is negative and estimates (-) 100 m.u. Amount of

taxes collected in the state budget estimates 310 m.u. Determine:

a) the state budget balanceb) the changes in equilibrium income if government cuts taxes to 300 m.u. and MPS

is 0.25.

6. The Problem. In an economy, government purchases of goods and services equal $950 bln.

Aggregate Income (GDP) equals to $5600 bln. The tax rate is 15 percent; autonomous taxes

are $220 bln; the interest rate on public bonds is 10 percent; the value of existing public bonds

is $1300 bln; public transfers equal $80 bln. Determine the state budget balance.

7. The Problem. The economy is characterized by the following indicators:

– Government Purchases (G) = 800 m.u.;– Gross Investments (I) = 700 m.u.;– Transfers (TR) = 200 m.u.;– Consumption (С) = 2800 m.u.;– Interest on the public debt (N) = 100 m.u.;– Taxes (T) = 700 m.u.

Determine:1) Private savings;2) Public savings.

Open questions: The public debt in Moldova and its consequences.