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Expansionary and Contractionary Fiscal Policy quiz

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  • What is the main goal of expansionary fiscal policy during a recession?
    The main goal is to increase aggregate demand to raise real GDP back to its potential output and reduce cyclical unemployment.
  • How does the government use spending to implement expansionary fiscal policy?
    The government increases its spending, which directly raises aggregate demand and shifts the AD curve to the right.
  • What effect does lowering taxes have in expansionary fiscal policy?
    Lowering taxes increases disposable income, which boosts consumption and shifts aggregate demand to the right.
  • In the AD-AS model, what happens to the price level when expansionary fiscal policy is used?
    The price level increases as aggregate demand shifts to the right.
  • What is the relationship between government spending and GDP in the context of fiscal policy?
    Government spending is a component of GDP, so increasing it raises GDP and aggregate demand.
  • What is contractionary fiscal policy designed to address?
    It is designed to reduce inflation and bring real GDP back down to its sustainable, long-run potential when the economy is overheating.
  • How does the government use spending to implement contractionary fiscal policy?
    The government reduces its spending, which lowers aggregate demand and shifts the AD curve to the left.
  • What is the effect of raising taxes in contractionary fiscal policy?
    Raising taxes decreases disposable income, which reduces consumption and shifts aggregate demand to the left.
  • What does 'overemployment' mean in the context of contractionary fiscal policy?
    Overemployment means more people are working than usual, often including overtime or those not typically in the labor force, due to an unsustainably high GDP.
  • What happens to the price level when contractionary fiscal policy is enacted?
    The price level decreases as aggregate demand shifts to the left.
  • Why does the government want to return the economy to long-run equilibrium?
    Returning to long-run equilibrium ensures GDP is at its sustainable potential and prevents prolonged inflation or unemployment.
  • Which components of aggregate demand are directly affected by fiscal policy?
    Fiscal policy directly affects government purchases and, through taxes, influences consumption.
  • How does expansionary fiscal policy affect unemployment?
    It reduces cyclical unemployment by increasing aggregate demand and moving GDP toward its potential.
  • What is the effect of contractionary fiscal policy on real GDP?
    It lowers real GDP by reducing aggregate demand, bringing output back to its long-run potential.
  • How are expansionary and contractionary fiscal policies similar to monetary policy?
    Both types of policies aim to stabilize the economy by influencing aggregate demand, though they use different tools (fiscal uses spending and taxes, monetary uses money supply and interest rates).