Question

4. Which of the following statements is (are) correct?
(x) If households view a tax cut as being temporary, the tax cut has more of an effect on aggregate demand than if households view it as permanent.
(y) A decrease in taxes is an example of an expansionary fiscal policy and that policy will probably cause the aggregate demand curve to shift to the right.
(z) An increase in government purchases coupled with a decrease in taxes is an expansionary fiscal policy that will increase the budget deficit.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only.
E. (x) only

5. which of the following statements is (are) correct?
(x) The multiplier effect is the multiplied impact on aggregate demand of a given increase in government purchases of goods and services.
(y) The marginal propensity to consume (MPC) is defined as the fraction of extra income that a household consumes rather than saves and the larger the MPC the larger the multiplier effect.
(z) According to the multiplier effect, an increase in government purchases causes interest rates to increase which increases investment spending.
A. (x), (y) and (z) B. (x) and (y) only
C. (x) and (z) only D. (y) and (z) only.
E. (y) only

Which of the following statements is (are) correct?
(x) According to the textbook, an increase in government spending on goods to build or repair transportation infrastructure and education facilities shifts the aggregate demand curve to the right and, in the long run, shifts the aggregate supply curve to the right.
(y) According to the crowding-out effect, an increase in government purchases causes interest rates to rise and the interest rate increase causes an increase in investment spending.
(z) The multiplier effect amplifies the effects of an increase in government expenditures, while the crowding-out effect diminishes the effects.
A. (x), (y) and (z)
B. (x) and (y) only
C. (x) and (z) only
D. (y) and (z) only.
E. (z) only

Answer 1

Ans 4) option D : Y and Z only

Only statements Y and Z are correct as a decrease in the taxes would result in higher incomes with the households, resulting in increase in demand and expansionary effect. Due to increase in demand, the aggregate demand curve will shift to the right.

Moreover, according to Permanent Income Hypothises by Milton Friedman, households will only increase its demand isftheir permanent income increases, which can only happen as a result of a permanent cut in taxes and not a temporary cut.

Ans 5) option B: X and Y only

Multiplier effect is in its essence refers to increase in income as a result of increase in investment spending. Government multiplier results in increase in income due to increase in government spending on goods and services. This is because, an increase in Government spending would infuse liquidity in the economy, resulting in higher income and demand.

Marginal Propensity to consume refers to the behaviour of households regarding the share they would spend on consumption of every additional dollar. Multiplier formula is given by 1/(1-MPC), therefore, the larger MPC, the smaller would be 1- MPC , implying larger multiplier.

Statement Z is not correct as increase in Government spending would no doubt result in increase in interest rates due to a rightward/ outward shift in the demand curve, but this increase in interest rates would decrease private investments as cost of borrowing capital would increase with the increase in interest rates.

Ans 6)Option E: Z only

Statement X is not correst as shits in aggregate demand and supply happens when on an aggregate the demand/ supply of goods in the economy changes and not due to increase/decrease in the demand/ supply of one or two particular goods.

Statement Y is also not correct as due to crowding out effect an increase in govt. spending would result in increase in interest rates which would wash out private investments, therefore investments would decrease and not increase.

Multiplier Effect does amplifies the effect of increase in govt expenditure as it tells about the increase in income due to increase in govt. spending as aggregate demand curve shifts to the right.

Crowding out effect on the other hands deminishes the impact of increase in govt spending as it tells about decrease in private spending due to increase in interest rates as aggregate demand curve shifts to the right.