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Long Run Effects of Fiscal Policy quiz

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  • What is a government budget deficit?
    A government budget deficit occurs when government spending exceeds its tax revenues.
  • How does the government typically finance a budget deficit?
    The government finances a budget deficit by borrowing funds, usually through issuing bonds.
  • What is the crowding out effect?
    The crowding out effect is when increased government borrowing raises interest rates, reducing private investment spending.
  • Why do interest rates rise when the government borrows more?
    Interest rates rise because the government competes with firms for loanable funds, increasing the demand for money.
  • How do higher interest rates affect investment spending?
    Higher interest rates discourage investment spending because borrowing becomes more expensive for firms.
  • What is the long-run impact of reduced investment spending due to higher interest rates?
    Reduced investment spending leads to stunted long-run economic growth, as fewer capital goods like factories and equipment are built.
  • How do persistent budget deficits affect future government budgets?
    Persistent deficits increase debt and interest payments, putting pressure on future budgets and possibly requiring spending cuts or tax increases.
  • What fiscal policy is recommended during recessions and expansions?
    It is recommended to increase government spending during recessions and run surpluses (spend less) during expansions.
  • Why is it difficult for governments to reduce spending after a recession?
    It is difficult because once increased spending programs are in place, they are hard to reverse or cut back.
  • What is a tax wedge?
    A tax wedge is the difference between pretax and post-tax income, representing the amount taken by taxes.
  • How do lower individual taxes affect disposable income and consumption?
    Lower individual taxes increase disposable income, which leads to higher consumption.
  • How do lower corporate taxes influence investment?
    Lower corporate taxes increase firms' returns, encouraging more investment.
  • How do lower taxes on savings affect the supply of loanable funds?
    Lower taxes on savings increase the incentive to save, raising the supply of loanable funds.
  • What is the effect of an increased supply of loanable funds on interest rates?
    An increased supply of loanable funds lowers interest rates.
  • Why is maintaining a balanced budget important in the long run?
    A balanced budget is important to avoid future tax hikes or spending cuts and to maintain macroeconomic stability.