ECO501 – PRINCIPLES OF ECONOMICS

Tutorial 10: AD, AS and Fiscal Policy

A. Multiple Choice Questions

1. The aggregate demand curve shows the relationship between the:
A) price level and real domestic output produced
B) price level and real domestic output purchased
C) price level that producers are willing to accept
D) real output purchased and produced

2. The slope of the aggregate supply curve shows that the ________ the price level, the
________.
A) higher; greater is the quantity of real GDP supplied
B) higher; smaller is the quantity of real GDP supplied
C) lower; greater is the quantity of real GDP supplied
D) higher; is the quantity of potential GDP supplied
E) lower; is the quantity of potential GDP supplied
3. If the price level increases, there is ________ the AD curve and the quantity of real GDP
demanded ________.
A) a movement upward along; increases
B) a movement downward along; increases
C) a movement upward along; decreases
D) a leftward shift in; decreases
E) no change in; does not change
4. A rise in the price level ________ the buying power of money and ________ the quantity of
real GDP demanded.
A) does not affect; increases
B) lowers; increases
C) raises; decreases
D) lowers; decreases
E) does not affect; does not change
5. As the general price level rises:
A) the demand for money and interest rates both increase
B) those with financial assets with fixed-money values increase their expenditures
C) interest-sensitive spending increases
D) those with financial assets with fixed-money values have increased purchasing powerp

6. In the short run, a rise in the price level brings a ________ in the real interest rate that
________ investment, bringing ________ in the quantity of real GDP demanded.
A) rise; decreases; a decrease
B) fall; decreases; a decrease
C) fall; increases; an increase
D) rise; increases; an increase
E) rise; decreases; an increase

7. An increase in aggregate expenditure shifts the aggregate demand curve:

A) rightwards by the level of increase in aggregate expenditure
B) rightwards by the level of increase in aggregate expenditure times the multiplier

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C) leftwards by the level of increase in aggregate expenditure
D) leftwards by the level of increase in aggregate expenditure times the multiplier

8. Changes in ________ cause a movement along the aggregate demand curve while changes in
________ shift the aggregate demand curve.
A) price level; taxes
B) taxes; government spending
C) government spending; price level
D) money wage rate; price level
E) price level; money wage rate
9. The aggregate supply curve shows the relationship between:
A) the general level of prices and real domestic output purchased
B) real domestic output produced and the general level of prices
C) the price level at which producers are willing to provide output and the price level purchasers are
willing to pay for this output
D) real domestic output purchased and real domestic output produced at each price level

10. An increase in aggregate supply will:

A) reduce both the price level and real domestic output
B) reduce the price level but increase real domestic output
C) increase both the price level and real domestic output
D) increase the price level but reduce real domestic output

11. The quantity of real GDP supplied increases when the price level increases because
A) investment increases.
B) the quantity of money increases.
C) the real wage rate falls.
D) the real wage rate rises.
E) aggregate demand increases.
12. During 2016, a country reports that its price level fell and the money wage rate did not
change. These changes led to
A) a higher real wage rate, lower profits, and a decrease in the quantity of real GDP supplied.
B) a higher real wage rate, higher profits, and an increase in the quantity of real GDP supplied.
C) a lower real wage rate, lower profits, and a decrease in the quantity of real GDP supplied.
D) a lower real wage rate, higher profits, and an increase in the quantity of real GDP supplied.
E) no change in the real wage rate and an increase in aggregate demand.
13. The quantity of real GDP supplied decreases if the price level ________ because it ________
profits.
A) rises; increases
B) rises; decreases
C) falls; increases
D) falls; decreases
E) None of the above answers is correct because the AS curve is vertical so that the quantity of real GDP
supplied does not change when the price level changes.
14. A rise in the price level brings a ________ in the real wage rate that ________ profits which
leads to ________ production.
A) rise; reduces; decreasing
B) rise; reduces; increasing
C) fall; increases; increasing
D) rise; increases; decreasing
E) fall; decreases; decreasing

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 15. An increase in business taxes will tend to cause a:
A) decrease in aggregate demand and a decrease in short-run aggregate supply
B) decrease in short-run aggregate supply but leave aggregate demand unchanged
C) decrease in short-run aggregate supply and increase aggregate demand
D) decrease in short-run aggregate demand but leave short-run aggregate supply unchanged
16. The ratchet effect is the result of:
A) a price level that is inflexible upwards
B) a price level that is downwards inflexible
C) an inability to decrease real domestic output
D) an inability to increase real domestic output
17. In the long run, demand pull inflation will have:
A) a negative effect on the level of nominal wages
B) a negative effect on the unemployment rate
C) a positive effect on the level of prices
D) a positive effect on the level of real domestic output
18. If there is stagflation in the economy caused by a decrease in aggregate supply:
A) both the real output and price levels would fall
B) real output would rise and increases in the price level would be greater
C) real output would fall while the price level increases
D) real output would increase while the increases in the price level would be smaller
19. If people's expectations about future income improve so they think their future income will
be higher than previously believed, then the AD curve
A) will not change until income actually rises.
B) will shift leftward because people will spend less now.
C) will shift rightward because people will increase spending now.
D) and the AS curve will both shift leftward because people will increase their saving.
E) will not shift, but potential GDP will increase.
20. If firms' expectations about the future become pessimistic so that they think future profits
will be lower, then
A) aggregate demand decreases and the AD curve shifts leftward.
B) aggregate demand increases and the AD curve shifts rightward.
C) the quantity of real GDP demanded decreases, and there is a movement up along the AD curve.
D) the quantity of real GDP demanded increases, and there is a movement down along the AD curve.
E) the aggregate demand curve does not shift, but potential GDP decreases.
21. Which of the following decreases aggregate demand and shifts the AD curve leftward?
A) a tax cut
B) a decrease in price level
C) a decrease in government expenditures
D) a decrease in the price of exported goods and services
E) a decrease in potential GDP
22. Aggregate demand ________ and shifts the AD curve ________ when ________.
A) increases; rightward; government expenditure increases
B) increases; rightward; taxes increase
C) increases; rightward; future expected profit decreases
D) decreases; leftward; foreign income increases
E) increases; leftward; government expenditure increases
23. Which of the following decreases aggregate demand and shifts the AD curve leftward?
A) a tax cut
B) an interest rate hike
C) an increase in quantity of money
D) an increase in government expenditures on goods and services

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E) a decrease in potential GDP
24. If a country is trying to recover from a recent recession, it is unlikely their government
officials will decide to ________ because it would ________.
A) lower interest rates; decrease aggregate demand
B) raise interest rates; decrease aggregate demand
C) raise interest rates; increase aggregate demand
D) institute a tax cut; increase aggregate demand
E) increase taxes; increase aggregate demand
25. An increase in the quantity of money ________ aggregate demand and ________.
A) increases; shifts the aggregate demand curve rightward
B) increases; shifts the aggregate demand curve leftward
C) decreases; shifts the aggregate demand curve rightward
D) decreases; shifts the aggregate demand curve leftward
E) increases; rotates the aggregate demand curve so it is steeper
26. Aggregate demand ________ and shifts the AD curve ________ when ________.
A) decreases; leftward; government expenditure increases
B) increases; rightward; taxes increase
C) decreases; leftward; foreign incomes decrease
D) decreases; rightward; government expenditure increases
E) increases; leftward; taxes decrease
27. 1The Government use discretionary fiscal policy to:
A) re-allocate resources between alternative uses
B) redistribute national income
C) promote economic stability
D) all of the above
28. If the gov’t wishes to decrease the level of real GDP, it might:
A) reduce taxes
B) increase its purchases of goods and services
C) increase the size of the budget surplus
D) increase the size of the budget deficit
29. Which if the following is not an automatic stabiliser:
A) personal income tax
B) unemployment benefits
C) welfare payments
D) expenditure on tertiary education
30. If the economy is to have built-in stability, when real GDP falls:
A) tax revenue and government transfer payments should both fall
B) tax revenues and government transfer payments should both rise
C) tax revenues should fall and government transfer payments should rise
D) tax revenues should rise and government transfer payments should fall

31. Fiscal drag refers to:

A) the tendency for tax receipts to rise when income rises
B) the effect of economic recessions on exports
C) the long lags between the announcement and implementation of fiscal policy
D) the reluctance of the government to grant tax changes quickly

32. The Cyclically adjusted budget deficit tells us:

A) the actual budget deficit
B) how the budget changes when GDP changes
C) what the budget would be if the economy were at full employment

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D) how the government’s fiscal ‘stance’ changes when GDP changes

33. If the government tries to get rid of a budget deficit in the middle of a recession, its efforts will:
A) alleviate the recession
B) be counter-cyclical
C) make the recession worse
D) have no effect on aggregate expenditure

34. The Public debt may be harmful because:

A) if it gets so large it will send the government bankrupt
B) it reduces the level of aggregate expenditure and therefore the level of real GDP and employment
C) the added taxes used to service the debt may reduce incentives to work, save and invest
D) the interest burden of the debt as a percentage of GDP is getting extremely large

35. The ‘crowding-out’ effect of an expansionary (deficit) fiscal policy is the result of gov’t
borrowing in the money market which:
A) increases interest rates and net investment spending in the economy
B) increases interest rates and decreases net investment spending
C) decreases interest rates and increases net investment spending
D) decreases interest rates and net investment spending in the economy

36. Assume that there is a recession and the gov’t pursues an expansionary fiscal policy. The likely
effect would be that:
A) there would be lower domestic interest rates and an increase in demand for dollars that would partially
offset the policy
B) there would be a depreciation in the value of SBD and decrease in net exports that would partially
offset the contractionary fiscal policy
C) there would be an increase in net exports and an increase in aggregate demand that would partially
offset the policy
D) interest rates and exchange rates would rise and, hence, net exports and aggregate demand would
decreases which would partially offset the policy

37. If tax cuts induce both demand-side and supply-side effects then:
A) both prices and output will fall because AD and AS will both shift to the left
B) both prices and output will fall because AD and AS will both shift to the right
C) prices will be lower and output higher than would have been the case if only AD had shifted
D) prices will be higher and output lower than would have been the case if only AD had shifted

B. Short-Answer Questions
1. Explain the impact of an increase in the general price level on the quantity of real domestic
output demanded giving reference to: interest-rate effect; the real-balances effect; and the
foreign-purchases effect.
2. What impact do the price-level increases have on the size of the multiplier? Explain, giving
reference to the AD-AS model
3. Explain two ways that the government may finance a budget deficit. Which has the greater
expansionary effect on the economy? Why?
4. What problems can arise from a large public debt? Are there any benefits to a larger public
debt?
5. What is meant by the term ‘crowding-out’? Why does expansionary fiscal policy result in
crowding-out?