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b.proper during slack economic conditions but highly inappropriate if the economy is already operating at capacity.

c.of little consequence unless there is a corresponding change in the money supply.

d.an effective method of dealing with inflation.

5.Which of the following is true?

a.Inability to forecast the future and political delays reduce the effectiveness of fiscal policy as a stabilization tool.

b.Legislative action is necessary if automatic stabilizers are going to smooth the ups and downs of the business cycle.

c.The crowding-out effect indicates that the expectation of higher future tax rates will undermine the potency of expansionary fiscal policy.

d.The new classical theory indicates that higher real interest rates will undermine the potency of expansionary fiscal policy.

6.The crowding-out effect suggests that

a.expansionary fiscal policy causes inflation.

b.restrictive fiscal policy is an effective weapon against inflation.

c.a reduction in private spending that results from higher interest rates caused by a budget deficit will largely offset the expansionary effects of the deficit.

d.a tax reduction financed by borrowing will increase the disposable income of households and, thereby, lead to a strong expansion in aggregate demand, output, and employment.

7.The supply-side effects of a reduction in taxes are the result of

a.increases in the disposable income of households accompanying reductions in tax rates.

b.the stimulus effects of increases in government expenditures.

c.increased attractiveness of productive activity relative to leisure and tax avoidance.

d.reductions in interest rates that generally accompany expansionary fiscal policy.

8.The new classical model implies that substitution of debt for tax financing

a.increases aggregate demand and exerts an expansionary effect on real output.

b.is highly effective against inflation.

c.reduces savings because it increases both the current and future tax liability of households.

d.leaves wealth, and therefore aggregate demand, unchanged because the debt will require higher future tax rates.

9.If a fiscal policy change is going to exert a stabilizing impact on the economy, it must

a.add demand stimulus during a slowdown but restraint during an economic boom.

b.exert an expansionary impact during all phases of the business cycle.

c.restrain aggregate demand during all phases of the business cycle.

d.keep the government’s budget in balance.

10.Since 1986, the top marginal personal income tax rate has been 40 percent or less compared to 70 percent or more prior to 1981. During the last 15 years, the share of personal income taxes collected from high income taxpayers

a.has declined sharply.

b.has been virtually unchanged.

c.has increased.

d.rose prior to the capital gains tax cut of 1997, but has fallen sharply since that time.

Answer Key 1 through 10

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